Income splitting: Five ideas to consider

No one can drive you crazy like family. Just ask Mazen Dayem of Staten Island, N.Y., whose restraining order against his father-in-law, Yunes Doleh, did not prevent Mr. Doleh from continuing to torment Mr. Dayem. How? By waving his hairpiece at him.

Evidently, the toupee looks like the Tasmanian Devil cartoon character, and Mr. Dayem has had a lifelong phobia of the Looney Tunes menace. The taunting got so bad that Mr. Doleh was arrested in November for violating the restraining order when he allegedly waved his hair at Mr. Dayem at a funeral. "It's just a very big fear of mine, his damn wig," Mr. Dayem told the New York Post. "It's a genuine fear. I have nightmares," he said.

Look, family should learn to get along. Life is much better that way, and can even be financially rewarding when family members work together to save money on taxes. How? By using one of the Five Pillars of Tax Planning: Dividing to save tax – otherwise known as "income splitting." Here are five ideas to consider:

• Lend money and charge interest. Consider lending money to a lower-income spouse or child. If you charge interest on the loan at the tax man’s prescribed rate (just 1 per cent until the end of March), then you’ll avoid attribution back to you of any income earned on the funds you’ve lent. The interest will have to be paid to you by Jan. 30 each year for the prior year’s interest charge and will be taxable to you. Your spouse or child can deduct the interest paid. And get this: the 1-per-cent rate can be locked-in indefinitely. But set this up before the end of March since it’s expected the prescribed rate will rise – possibly on April 1.
• Transfer money to cover loan interest. The name of the game here is putting investments into the hands of a lower-income family member where any income from those investments will be taxed at his or her lower tax rate. So, consider having your spouse borrow money to invest. You could then gift your spouse the cash necessary to make the interest payments on the loan. It’s important that you don’t guarantee the loan, or pay down the principal owing. The attribution rules, which can cause income to be attributed back to you, shouldn’t apply in this case.
• Make a corporate loan to a related student. If you own a corporation, consider setting up a loan from the corporation to a student who is not dealing with you at arm’s length. If the loan is not repaid within one year of your company’s year-end, it will be taxed in the hands of the student. No big deal: The student will likely pay little or no tax on the amount if he or she has got very little other income. Once the student graduates and is earning a regular income, the loan can be repaid at that time and the student will be allowed a deduction for the repayment. Not a bad deal: Little or no tax to pay when the loan is included in income, but a useful deduction when it’s repaid later. This idea works well if the student doesn’t work in the business and it would be tough to justify paying salary or wages. Keep in mind, too, the company won’t be entitled to a deduction for the cash paid to the student – after all, it’s a loan.
• Invest Canada Child Benefits properly. In 2016, the Canada Child Benefit was introduced to replace the Canada Child Tax Benefit, Universal Child Care Benefit and the National Child Benefit Supplement. Did you realize that Canada Child Benefit payments can be invested in your child’s name without any earnings being attributed back to you? It’s true. Ensure the payments are deposited directly into an investment account for your child and consider investing those funds for the long-term – perhaps to help with your child’s education.
• Pay an adult child to baby-sit the younger kids. Consider paying your adult child who was 18 or older in the year to baby-sit your younger kids who were age 16 or under in the year. Babysitting fees, like other child-care expenses, may be deductible if they were paid out to allow you to earn income. You’ll be entitled to a deduction and your adult child will report the payments as income. If your child has little or no other income, there’s a good chance that he or she will pay little or no tax on those fees and will have earned income which will create RRSP contribution room for use later.

Tim Cestnick, FCPA, FCA, CPA(IL), CFP, TEP, is an author, and co-founder and CEO of Our Family Office Inc.