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Income splitting tips for 2018

Doctors are braced for a steep hike in personal taxes this year when they are no longer able to split income with family members the way they used to.

On January 1, 2018, the “tax on split income” (TOSI) rules became effective. This severely restricts income splitting and will impose the top personal tax rate on dividends, capital gains and certain income from partnerships and trusts. For many of our clients the increased tax burden exceeds $50,000 annually.

There are some instances, though, which exempt you from TOSI rules.

  1. Salaries paid to family members are exempt, but the amount is limited to what is reasonable. The basic test for “reasonableness” is the salary you would pay for services rendered by a person not related to you.
  2. A doctor can pay dividends without restriction to any family member 18 years or older who works an average of 20 hours per week at the practice during the current year or five preceding years. The doctor must keep timesheets or logbooks to substantiate the work performed to satisfy CRA auditors.
  3. The spousal age exemption. A doctor can still transfer income to a spouse once the doctor turns 65.
  4. Certain loan arrangements between the doctor and the family members.

Below is an illustration of an income splitting arrangement that would not be caught by the new rules.

Dr. Bob has a loan arrangement to split investment income with family members in a lower tax bracket. Dr. Bob’s spouse or family member borrows $1-million from the bank to make investments. The loan is secured by the investment assets. It is important that Dr. Bob does not personally guarantee the loan or make the payments. However, he is permitted to gift the family member an amount equal to the loan interest. The investment income is now reported on the family member’s tax return, not Dr. Bob’s.

To illustrate how this works, the annual return on the $1-million investment is 8 per cent and the loan interest is 3 per cent. The family member, having no other income, is required to report $80,000 less the interest expense of $30,000 for a net income of $50,000. The family member will pay personal tax of $8,000, much less than the $23,000 Dr. Bob would pay at the highest tax rate. In total, the family realizes a substantial saving of $15,000.

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