An important planning opportunity exists where one spouse is in a lower income tax bracket than the other. It involves loaning funds from one spouse to the other.

You may consider lending your spouse some money if your spouse is in a lower income tax bracket than your own or in a low income. You will be pleasantly surprised by the benefits of this opportunity.

The key is to charge interest at least at the Canada Customs and Revenue Agency prescribed rate on all funds loaned to your spouse. The rate for the first quarter ending March 31, 2002 is set at 3%.

The great news is that the prescribed rate drops to 2% for the second quarter ending June 30, 2002. Better yet, the loan rate can be locked in for a long period of time.

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 not later than January 30 of each year following the loan.

As an example, one spouse loans $200,000 to the other at 2% who invests it at 5%. The recipient spouse is taxed on the 3% difference.

In this instance, an annual income amount of $6,000 is shifted to the lower income spouse. In a long-term arrangement, all investment income in excess of 2% is taxed in the hands of the lower tax bracket spouse.

Documentation is required between the spouses as evidence of the loan. Further, there must be actual interest payments made, and the lending spouse must report the 2% loan interest income.

This is one of the few forms of income splitting still available to spouses. Over time, the lower income spouse can accumulate a bigger nest egg. It can then be used as a source of income for now and during retirement.

The CCRA prescribed rate is set every calendar quarter. The upcoming 2% prescribed rate is the lowest that it has been and it may rise for the third quarter.

Loans of this type between spouses should be made for investment as opposed to consumption purposes. The recipient spouse will have to pay the prescribed rate regardless of the loan purpose.

For business owners, there are other variations on this income splitting opportunity that involve family trusts and loans to shareholders. The shareholder loan rules are much more involved, hence, seek professional counsel.

Clearly, this income splitting provision can achieve 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 upcoming 2% rate. All strategies, arrangements and documentation must be in place between April 1, 2002 and not later than June 30, 2002.
 

NOTE: The information provided above is intended for general informational purposes only. It does not constitute advice for anyone's specific situation. Everyone should always first consult directly with their advisors to determine the appropriateness of any information contained above before taking any action. KCM Wealth Management Inc. assumes no responsibility for any loss or damage arising from the use of, or reliance upon the above information.