Creating wealth is partly about minimizing the amount of tax you're paying annually.
Think of it this way: Introducing just one or two tax strategies into your planning each year can have a cumulative effect that can make a big difference in the level of your wealth over time.
Last week, I introduced the idea that there are five pillars of tax planning. Any tax strategy you might come up with will fall under one or more of these pillars. Here's the plan: Explore each of these pillars and arrive at one or two ideas in 2012 that will save you tax this year, and potentially in future years as well.
Last week, I shared some ideas under the first two pillars, "deducting" and "deferring." Today, I want to talk about the next pillar: "Dividing."
It is simply the idea of splitting income among family members. Specifically, it involves moving income from the hands of one family member who may pay tax at a higher rate to another who will pay tax at a lower rate. Consider these ideas:
- Lend money to your spouse. If you lend money to your lower-income spouse it's possible that any income he or she earns on those funds can be taxed in his or her hands rather than yours. You'll need to charge the prescribed rate of interest on that loan (currently 1 per cent – it's never been lower. Your spouse must pay the interest by Jan. 30 each year for the prior year interest charge). You'll have to report that interest income paid by your spouse, but he or she will get a tax deduction for it. Your spouse can now report all the income earned on those lent funds. As long as your spouse is earning more than 1 per cent on the invested money, you'll come out ahead as a family.
-Split pension income. You may be aware that the government introduced pension income splitting in 2007. Today, you may be able to allocate up to one half of your eligible pension income to your spouse or common-law partner. The amount allocated can be deducted by you, and your spouse or partner will have to report that portion of your pension income. It's worthwhile doing some number crunching each year to determine the exact amount that should be transferred to your spouse. Tax software, or a tax pro, can help here.
- Give growth assets to the kids. Whether your kids are minors or adults, you'll be able to effectively have the growth on assets of your choosing taxed in their hands rather than yours. If the assets have appreciated in value already, you should count the tax cost of putting these assets into the name of a child (either directly in their names or in trust for them). Also, be aware that you could be giving up the right to own that future growth by transferring assets to a child or a trust for them. In fact, a family trust can allow you to continue to control the assets and potentially take them back at a future date if you are also named a beneficiary of the trust. Speak to a tax pro for more details.
-Swap assets with a family member. You can transfer income-producing investments to an adult family member and take back, in exchange, assets of equal value that do not produce income (such as jewellery, artwork, or his half of your family home). This will be treated as a sale at fair market value by each of you – so count the tax cost first. After the swap, your lower income family member will have income-producing assets and that income will be taxed in his or her hands, not yours.
-Give shares that will pay capital dividends. If you own shares in a private company that has earned capital gains in the past, will do so in the future, or will be the recipient of life insurance proceeds at some point, you may want to gift or issue shares of that corporation to a lower-income family member, or a trust for them. Capital gains and life insurance proceeds in a private Canadian corporation can give rise to a "capital dividend account" balance, and dividends paid out of this account are not taxable. Therefore, those dividends can be paid out to a lower-income family member and will not result in taxable income being attributed back to you (which can be the case with other dividends or income).
Next week: The "disguising" and "dodging" pillars
Tim Cestnick is president and CEO of WaterStreet Family Wealth Counsel and author of 101 Tax Secrets for Canadians.