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PAGE 8 COMMENT OctOber 6/13, 2008 • Law times reducing the penalty for such en- deavours. The basics are simple: Split income; T 1. he reward of energy, en- terprise, and thrift is tax- es. Tax planning is about 2. Shift income; 3. Defer income; 4. Convert income; 5. Maximize deductions. Basics of income tax planning Financial minimize, or extinguish taxes payable to the extent allowed by law and within acceptable pa- rameters of risk. Income splitting is an effective tool of tax planning because it al- lows one to reduce the marginal rate of tax. The marginal rate of tax is the rate that applies to an individual's top tax dollar. For example, an individual earning $200,000 a year has an effective federal marginal rate of tax of 29 per cent — the rate of tax that he or she must pay on the top dollar of earnings. Combined with pro- vincial taxes, the top marginal rate is about 46 per cent in Ontario, 39 per cent in Alberta, and 48 per cent in Nova Scotia (2008). Where an individual can reduce the marginal rate of tax by splitting his income between two or more persons, the total tax payable by the taxpayers will drop because each of the taxpayers will have a lower marginal rate. Obviously, one splits income only with other individu- als whom we wish to benefit. No one splits income with complete strangers merely to reduce their marginal rate of tax. The objective is to reduce, ma and Jane are married and live in Ontario. Karma earns $150,000 a year and Jane — a stay-at-home mother — has no income. They have two chil- dren, ages 10 and 19. Karma would pay tax of about $51,000 in 2008. The family could re- duce its overall tax bill if Karma could split his income with Jane and the children. For example, if Karma earned $100,000 and Jane earned $50,000, their combined tax bill would be about $38,500 — a savings of $12,500. Understandably, the Income For example, assume Kar- Matters By Vern Krishna his investments into Jane's name, the act will attribute any income that Jane earns on those invest- ments to Karma and will be tax- able in his hands as if he earned the income directly. Of course, Jane would not be taxable on the investment income. Notwithstanding the strict rules against income splitting, there are certain circumstances in which in- dividuals can arrange their affairs to facilitate income splitting. For example, the act specifically allows Tax Act has strict rules to prevent blatant income splitting between family members. For example, if Karma is an employee, he cannot simply direct his employer to pay one-third of his salary ($50,000) to his wife Jane. If he does, the ITA will tax Karma as if he earned the entire $150,000 even though the employer remitted $50,000 directly to Jane. Similarly, if Karma transfers a taxpayer to contribute to his spouse's registered retirement sav- ings plan. If, for example, Karma contributed $5,000 to Jane's reg- istered retirement savings plan, he could deduct his contribution from his own tax return. Thus, he would deduct his contribu- tion and save 46 per cent of the amount contributed in tax. When Jane deregisters the registered re- tirement savings plan and extracts the funds, the act will tax her on the funds at her lower rate of tax. Indeed, depending upon her total income and personal credits, her tax rate may be zero. Thus, the parties would have legally split their income by using the statuto- ry provisions applicable to spousal registered retirement savings plan. Similarly, where two taxpayers When it comes to borrow- ing money for investment pur- poses, it makes sense for the higher marginal rate taxpayer to borrow. In the above example, if Paula borrowed $100,000 to invest in stocks that paid minimal — if any — dividends, she would be able to deduct her interest expense and save 46 cents on each dollar that she borrowed. In contrast, if her spouse borrowed the same amount of money, he would be saving only 30 cents on each dollar because he has the lower marginal rate of tax. Income splitting with children Thus, the husband would re- tain 70 per cent of his invest- ment income. In contrast, Paula would retain only 54 per cent of her investment income. splitting income and saving taxes on the investment income at his marginal rate of 46 per cent. If the child has a substantially lower, if any, marginal rate of tax, the fam- ily would save taxes on the invest- ment income. The table below illustrates the amount of tax saving — at 2008 Ontario rates — if we $200,000 income into two equal portions of $100,000 and into four equal portions of $50,000. Clearly, income splitting can divide have different marginal rates of tax, they can save the total tax pay- able between them by adjusting their spending and investment de- cisions. For example, assume that Paula's marginal tax rate is 46 per cent and her spouse's rate is 30 per cent. If they want to save $20,000 a year outside a tax sheltered plan, it is better for the husband to save the $20,000 out of his income be- cause any investment income will be taxable to him at 30 per cent. is more complicated and depends upon the age of the children. Generally, it is very difficult to split income with children under the age of 18. There are, how- ever, opportunities for splitting income with children over 18. In the above example, if Karma gave his adult child $20,000 to invest, the income thereon would be taxable to the child and not to Karma. Thus, Karma would be Income level per person $200,000 $100,000 x 2 $50,000 x 4 save a family substantial tax if done properly. The `table also il- lustrates the marriage penalty. There is a substantial tax increase if only one spouse earns all of the family income. The family's after- tax economic position improves considerably if both spouses earn an equal, albeit lesser, amount. Tax planning is about rewarding energy, enterprise, and thrift. It is open to everybody in much the same way as is the Ritz hotel. LT Vern Krishna, QC, FCGA, is tax counsel with Borden Ladner Ger- vais LLP and executive director of the CGA Tax Research Centre, University of Ottawa. His e-mail address is vkrishna@blgcanada .com Tax $74,460 $57,490 $39,364 Howard A. Levitt The Law of Contracts, Fifth Edition Stephen M. Waddams This classic text has been cited repeatedly by the courts, including the Supreme Court of Canada. This work looks beyond the surface rules of this complex area of law to identify the underlying conflicting principles. The fifth edition has been revised and updated to incorporate all the latest developments in contract law. Robert Hubbard, Susan Magotiaux and Suzanne Duncan This resource will help you understand privilege laws and how to use them. 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