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| Adrian Mastracci, president of KCM Wealth Management, says “We may not see the 3% rate again for a long time. Perhaps, the time is here to untie the ribbons." |
Vancouver, BC (March 3, 2006): The prescribed rate is set to rise next month from the current 3% to 4%.
Accordingly, an important planning opportunity exists where one spouse, including a common-law partner, is in a lower income tax bracket than the other. It involves loaning funds from one spouse to the other.
Ruth Ann Schabacker once said, “Each day comes bearing its own gifts. Untie the ribbons.”
Adrian Mastracci, investment counsel at Vancouver based “fee-only” KCM Wealth Management comments, “You may consider lending your spouse some money if your spouse is in a lower income tax bracket than your own, or has low income. The benefits are well worth looking at.”
We may not see the 3% rate again for a long time. Perhaps, the time is here to untie the ribbons.
The key is to charge interest at least at the Canada Revenue Agency prescribed rate on all funds loaned to your spouse. This has nothing to do with loan rates at your favourite lending institution.
The good news is that the prescribed rate is 3% for the quarter ending March 31, 2006. Better yet, the loan rate can be locked in for a long period of time, say five to ten years or more.
The recipient spouse invests the funds and reports the income earned on the investments. However, the recipient must pay the interest to the lender spouse before January 30 of each year following the loan.
Say one spouse loans $100,000 to the other at the 3% prescribed rate who then invests it at 5%. The recipient spouse is then taxed on the 2% difference. In this instance, an annual income of $2,000 is shifted to the lower income spouse.
Making this a long-term arrangement has plenty of planning appeal. All of the investment income in excess of 3% can be taxed in the hands of the lower tax bracket spouse.
The following also applies to spousal loans:
- Documentation between the spouses is required as evidence of the loan.
- There must be actual loan interest payments made to the lending spouse.
- The lending spouse reports the 3% loan interest income.
- The prescribed rate rises on April 1, 2006 to 4%.
- Make sure you pay attention to all the rules.
This is one of the few forms of income splitting still available to spouses. Over time, and depending on the amount of funds loaned, the lower income spouse can accumulate a bigger nestegg.
It can then be used as a source of income both now, and during those financial independence or retirement years.
Loans to a spouse should be made for investment purposes. The recipient spouse pays the prescribed rate regardless of the loan purpose.
You may already have such a loan at a higher interest rate. Hence, a new loan could be used to refinance the existing one at the lower rate.
For business owners, there are other variations on this income splitting opportunity that involve loans to shareholders. The rules are much more involved. Therefore, seek professional counsel.
Some uses for prescribed loans from the employer or your business are the purchase of your home or automobile.
Analyze how you may benefit from this provision. Some financial rearrangements may be necessary.
Clearly, this income splitting provision can provide significant income tax savings. Especially over a number of years.
Follow the rules closely if you intend to take advantage of this planning opportunity at the 3% rate. All strategies, arrangements and documentation must be in place not later than March 31, 2006.
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