There’s an old saying that two can live cheaper than one. When it comes to taxes in Canada, your marital status — whether you’re single, married or living common law — can make a significant difference in the amount of tax you pay each year.
Unlike the United States, where couples can choose to file a joint tax return, each spouse or partner in Canada must file his or her own tax return and clearly indicate their marital status on the first page. Common-law partners are defined as two people who cohabit in a conjugal relationship for at least 12 months and are treated the same as a legally married couple for tax purposes.
While partners must file individual tax returns, it’s a good idea to prepare them together.
“We suggest you prepare them together or have the same preparer do both so that you take full advantage of credits available, such as the age, pension income, disability and tuition and textbook credits,” said Sara Kinnear, senior tax and estate planning specialist with Investors Group.
“If one partner can’t use the credits, they may be able to transfer the unused portion to the other partner and reduce his or her tax.”
By preparing their returns together, couples will be able to determine whether they can split their income and whether they can claim some benefits such as the GST/HST credit, the child tax benefit or the guaranteed income supplement, which are based on the family’s total income.
For couples where one partner is in a higher tax bracket than the other, they may consider splitting income through a spousal loan.
Typically, when funds are loaned by one spouse to another, the income earned on the funds is taxed in the hands of the spouse who loaned the money. However, there is an exception to this rule that provides an opportunity to split income.
The exception applies if the borrowing spouse pays interest to the lending spouse at the prescribed interest rate in effect at the time the loan is made. Since April 2009, the prescribed rate has been one per cent, the lowest rate in Canadian history.
The loan is made pursuant to a written agreement and interest payable on the loan each year must be paid no later than 30 days after the year end or the lending spouse will have to report the income.
Grant Thornton LLP illustrates it as follows.
Jim invests $100,000 and earns income of $5,000. If Jim is taxed at the highest marginal rate of 45 per cent, he will pay tax of $2,250 on this income. Alternatively, Jim could loan $100,000 to Jennifer and charge the prescribed interest rate, which currently is one per cent. Jim will be taxed on the $1,000 of interest earned on the loan, paying $450 in tax.
Jennifer will invest the funds that she borrowed from Jim at a return of five per cent. Since she can deduct the $1,000 she pays to Jim as an interest expense, she will report $4,000 of net investment income. If Jennifer is taxed at the lowest marginal rate of 20 per cent, her total tax liability will be $800 ($5,000 - $1,000 = $4,000 x 20 per cent). Jim and Jennifer’s combined tax liability will be $1,250, a combined savings of $1,000.
Grant Thornton notes that even if the prescribed rate increases in the future, the prescribed rate on the loan will stay at one per cent for as long as the loan is outstanding.
“Although each person files their own return, it’s very important that they talk to each while the returns so they know what they can claim,” says Kinnear.
Talbot Boggs is a Toronto-based business communications professional who has worked with national news organizations, magazines and corporations in the finance, retail, manufacturing and other industrial sectors. He can be contacted at boggsyourmoney@rogers.com.