By Evelyn Jacks, President and Founder, Knowledge Bureau
For most people, moving in with a partner one loves and respects is one of life’s most significant and often daunting, events. Co-habitation has lots of tax consequences and some couples will want to know the details, to enable them to benefit the most from the myriad opportunities available. There are four important tax issues to consider:
From singles to spouses
For tax filing purposes, each individual who is a resident in Canada must report worldwide income in Canadian funds on their own personal income tax return. Each individual is entitled to his or her own Basic Personal Amount deduction. As well, the taxable income of each taxpayer is subject to “progressive” tax rates. This ensures that the higher the individual’s income, the more tax to pay. However, some things may change from a tax filing point of view, when gets married or cohabitates
To understand this better, let’s begin with some definitions. Who is a spouse for tax purposes? Simply put, this is the person with whom you have a “conjugal” relationship. This may fall into one of two specific categories:
- A “spouse” is someone to whom an individual is legally married.
- A “common-law partner”, is a person who is not a spouse but is:
o A person of the same or opposite sex with whom an individual has lived with (?)in a relationship throughout a continuous* 12-month period, or
o Someone who, at the end of the tax year, was the actual or adoptive parent of the other person’s child.
* Note that separations of less than 90 days do not affect the 12-month period.
For the purposes of this article, the word “spouse” will be used to represent both scenarios, because for income tax purposes rules that apply to a spouse apply equally to a common-law partner.
Net family income:
When one is in a conjugal relationship (either married or living common-law) each individual will still file a separate tax return, because there is no joint filing in Canada as there is in the United States.
For certain provisions; however, it is the combined net “family” income that needs to be considered. This will happen if you are applying for certain federal credits like the GST/HST Credit and benefits like the Canada Child Benefit. In some cases, there may be additional provincial tax credits that apply similar rules. For example, taxpayers in Ontario may receive an additional Ontario Child Benefit, whereas those in Manitoba may receive a Manitoba Personal Tax Credit, and in B.C., a provincial sales tax credit.
When the combined family net income exceeds certain income thresholds, a “clawback” of the credits occurs. This creates a double negative: the family will pay more tax as incomes rise and also receive less money from refundable credits and benefits.
A good defence against this double whammy is to invest in a Registered Retirement Savings Plan (RRSP). New couples will find that RRSPs contribution can result in tax deductions that in turn reduce family net income to preserve or increase those credits and benefits, while at the same time, reducing the overall family tax burden.
Individual net income:
Your spouse’s net income is taken into consideration when claiming the spousal tax credit, the Canada caregiver amount, or medical expenses. There are also instances where non-refundable tax credits can be transferred between spouses. For these reasons, keeping a keen eye on each individual spouse’s net income level and managing the type of investment earnings, can be a good tax-savings strategy.
Managing investments and their earnings:
There are planning opportunities in managing investment income reporting requirements, as not all income sources from investments are taxed alike. This can yield positive outcomes to the taxes payable and the credits or benefits a family receives.
For example, earning capital gains in non-registered accounts will provide the highest after-tax rewards over the long run. The accrued gains are never included in income until a disposition occurs, and at that time, only 50% of the gain is added to income.
Dividends provide a different result. Because actual dividends received are “grossed up,” this reporting requirement will artificially increase individual and family net income. If dividend income is over-weighted, therefore, that will also affect the size of refundable and non-refundable tax credits and social benefits, like Old Age Security and Employment Insurance benefits.
Interest income is fully taxable, but further tax costs occur when interest earnings from a compounding investment must be pre-reported. In this case, the consequence is that family net income is increased before the interest is actually received, resulting in credit reductions and increased taxes payable, in some cases.
Family income splitting:
Family income splitting is the process of shifting income from one family member who has a higher marginal tax rate to that of family members who have lower marginal tax rates. Couples who attempt to follow this strategy, must be mindful of the attribution rules which generally require the higher earner to report the income.
Nevertheless, there are several ways to split income legitimately. Three common examples are:
- Making contributions to a spousal RRSP,
- Using an election to split eligible pension income, and
- Drawing up inter-spousal investment loans
In the latter instance, when the lower income spouse borrows capital from the higher earner, it’s possible for the lower-earning spouse to report the resulting income, provided the parties sign a bona fide loan that bears an interest rate which is at least the lesser of:
- The “prescribed” interest rates in effect at the time the indebtedness was incurred (currently 2%) or,
- The rate that would have been charged by a commercial lender.
If the above steps are not taken, attribution rules may apply, and income earned would become taxable at the lender spouse’s hand.
Who claims the interest earned in joint accounts? It’s not necessarily reported by the person whose name is on the account, but rather, must be reported based on the ratio of “own source” contributions made to the account. If you each contributed 50% of the funds, you’ll each report 50% of the investment earnings.
Potential financial strategy:
Give your new spouse the money to invest in a Tax Free Savings Account (TFSA). The resulting earnings are tax-free, and because of these features, there is no attribution rule, as long as the money remains in the TFSA.
Entering into a marriage or deciding to live together in a common law relationship is an important step for many couples – in your excitement to begin your life together, don’t forget to look into potential tax benefits from your new union.
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