Wednesday, May 23, 2012

Income Splitting with TFSAs

Two people who each earn $100,000 per year generally pay less combined income tax than an individual making $200,000 per year. This creates a strong incentive for couples to find ways to balance their incomes. One way to achieve income splitting is to try to shift non-registered investments from a higher-earning spouse to a lower-earning spouse. The TFSA rules seem to permit a strategy for shifting assets between spouses.

Let’s illustrate this with an example. Alice is a doctor making $200,000 per year. He husband Ted watches the children and makes no income. Over the years Alice has maximized her RRSP and TFSA contributions and in addition has built up significant non-registered investments that produce income. Unfortunately, this income is highly taxed in her hands.

If the non-registered investments belonged to Ted, the couple would pay less income tax each year. However, if Alice simply gives the assets to Ted, CRA attribution rules say that the income derived from the investments would be taxed in Alice’s hands.

But Alice is allowed to contribute to Ted’s TFSA. Ted currently has his full $20,000 of TFSA room available. What if Alice were to contribute $20,000 to Ted’s TFSA, and Ted then withdraws it and places it in a non-registered account? I couldn’t find anything in TFSA rules saying that future income from this money would be attributed back to Alice. (Update: see the comments below for The Blunt Bean Counter's explanation of why this would be prevented by income attribution rules.)

If this works, then Alice could give $20,000 to Ted this year, $25,000 to Ted next year, and so on. After a decade, she could shift a total of at least $425,000 (more if yearly TFSA limits rise). It would then be Ted who declares interest, dividends, and capital gains on these investments each year.

I’d be interested to hear expert opinions on whether this strategy would run afoul of income attribution rules, unfair advantage rules, tax avoidance rules, or any other problems.

7 comments:

  1. Only politically favoured demographic groups get to split income. The simple answer is that if there isn't a rule against this, it won't matter. Four or five years down the line, they'll apply the GAR and crush anyone who did it.

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  2. The Blunt Bean CounterMay 23, 2012 at 8:47 AM

    Michael, nice try

    Subsection 74.5(12) of the Income Tax Act contemplates such. The attribution exemption only applies while the funds remain in the TFSA and only to the extent the contribution is made using the spouses available TFSA contribution room.

    Also, the CRA would definitely apply GAAR or some anti avoidance section to the withdrawal plan you suggest.

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  3. @Matt and @Mark: I knew someone would find the relevant law. My little scheme stays within the spouse's TFSA room, but fails when money is withdrawn. I predict that people will do this anyway even if it violates the rules.

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  4. Great idea Michael, but I'm glad that there is a rule against it.

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  5. Darn accountants!! and a Leaf fan to boot!

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  6. Blunt Bean Counter,

    I found this on another website:

    http://www.roxannehaddrell.com/tfsa.html

    Even after withdrawing the funds from the TFSA, no attribution rules are in effect. The CRA has stated that since there is no such thing as a "Spousal TFSA" that any and all funds withdrawn from the plan are the property of the TFSA owner (per phone call to CRA Oct 12, 2012). This means that money can be withdrawn and reinvested outside of the TFSA without the resulting income being attributed to the first spouse.

    So now I'm really confused.

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  7. Blunt Bean Counter,

    I found this on another website:

    http://www.roxannehaddrell.com/tfsa.html

    Even after withdrawing the funds from the TFSA, no attribution rules are in effect. The CRA has stated that since there is no such thing as a "Spousal TFSA" that any and all funds withdrawn from the plan are the property of the TFSA owner (per phone call to CRA Oct 12, 2012). This means that money can be withdrawn and reinvested outside of the TFSA without the resulting income being attributed to the first spouse.

    So now I'm really confused.

    ReplyDelete