Tuesday, June 12, 2012

Building Assets for the Lower-Earning Spouse

For couples with the happy problem of having used up all their RRSP and TFSA room, excess savings in taxable accounts generate income that gets taxed. Usually, it’s better if the lower-earning spouse with a lower marginal tax rate declares this investment income, but attribution rules get in the way. Here we look at a way to build assets in the name of the lower-earning spouse.

Let’s use an example to avoid using the awkward term “lower-earning spouse” any further. Jim has a soul-destroying corporate position paying $200,000 per year. His wife Sandy makes $35,000 per year selling flowers in a small shop. They have used all their RRSP and TFSA room. They have additional savings that build up in a taxable account.

If Jim and Sandy do nothing special, the taxable account would likely be full of money from Jim’s income and Jim has to declare the returns generated by this account on his taxes (even if the account is in Sandy’s name). If Sandy could declare this income, the couple would pay less tax overall.

The solution is to have all of Sandy’s income go into a taxable account in her name, and for the couple to use Jim’s income to pay family expenses. This way the taxable account would be full of Sandy’s income and the investment returns would be taxable in her hands. This is an approach that my wife and I use.

An interesting question is how far can Jim and Sandy push this? In a safe version of this idea, Sandy saves only her take-home pay and she pays any income taxes she owes at the end of the year herself. Here are some questions about whether this can be taken further in order to increase the amount of savings in Sandy’s name.

1. Can Jim pay any additional income taxes Sandy owes at the end of the year?

2. Can Jim reimburse Sandy for the taxes deducted from her paycheques? The idea here is that Jim pays all of Sandy’s taxes.

3. If Sandy owns the flower-selling business, can Jim pay the businesses expenses so that Sandy is free to save her total revenues rather than just her net income of $35,000?

One opinion I’ve received on these questions is that #1 might be okay, but could be a problem, #2 is definitely pushing it, and #3 is just inviting tax problems. I haven’t tried any of these ideas and I have no interest in breaking tax rules, but I would like to know for certain whether any of these 3 is deemed acceptable by CRA.


  1. I do not see how either of the actions you suggest can possibly be considered legitimate by CRA under the current legislation.

    You are talking about personal (!)income taxes, which are meant to be paid by a person that incurred income. IMHO, legally Sandy can invest up to her take home pay.

    Another strategy could have been to hire Sandy to do some home work, but this option is closed by CRA too.

    What John can do, I think, is to become a shareholder of Sandy's corporation, and through investment increase Sandy's income. While buying into Sandy's business he can create a one time tax free cash transfer to Sally, since first $500K of proceeds from the sale of business are not taxable. This would not solve the "problem" permanently, but at least will provide some temporarily relief.

  2. @AnatoliN: Do you have a pointer to the relevant legislation? It is clearly legal for Jim to do any of the things I listed; the only question is whether any of the gains from Sandy's savings would be attributed back to Jim.

  3. Jim can lend money to Sandy at the prescribed loan rate set by the CRA (which is very low - I don't have it on me at the moment).

    Then Sandy can quite legally invest the money (stock market or her business) and pay taxes on the profit under her own name, as long as she pays Jim the interest every year on the money she borrowed from him. Jim must pay tax on this interest.
    This is not worth it if she just puts it in a high-interest savings account - to make it worth while she has to earn more than she is paying Jim.

  4. Don't couples file taxes together in the US? I wonder why we don't do that in Canada.

  5. @Anonymous: This is true, but somewhat risky. If the investments lose money, what are the consequences of Jim forgiving part of the loan?

    @Patrick: I'm not sure. I don't know how much advantage U.S. married couples get from filing jointly.

  6. I think if you forgive the spousal investment loan the worst thing that could happen is the CRA declares the whole think invalid and attributes the investment back to the lender. That's a neutral thing at worst if there are losses.

  7. I understand that Jim could give Sandy money to contribute to her TFSA. Since TFSA income is not taxable, there is no investment income to attribute back to Jim.

  8. @Jeremy: This is true and is a big help to families with unbalanced incomes. But once both TFSAs are filled up, couples need some other strategy.