(June 2008) The cake’s been cut, the closets assigned, and your life of living together is in full swing. Whether you’ve gone the formal route or simply shacked-up, come tax filing time the warm and fuzzy will give way (ever so briefly) to the cold reality that it’s time to sort and report your economic union. So here’s an overview of the key tax implications of being a spouse.
Individual taxation: A blurred principle
In principle, the Canadian income tax system treats each individual as a separate economic unit. In reality, the personal and economic dependence in relationships can blur the distinction from one individual to the next.
As a result, our system recognizes select relationships — in particular, spouses — as being sufficiently closely connected that each individual’s tax liabilities and tax benefits should also be connected.
So, who is a spouse?
If your client is legally married, he or she is a spouse.
Short of that it is not so obvious, in large part because the term ‘common-law’ is defined differently from province to province for family property rights and parenting matters.. For income tax purposes, your client is a spouse if they live with another person in a conjugal relationship, whether that person is of the same or opposite sex, and
Opportunities through credit transfers
Every Canadian is entitled to claim a basic personal amount to reduce their federal and provincial taxes. For 2008 the federal basic amount is $9,600; some provinces use that number, others have different figures.
The system understands, however, that some residents will leave the workforce after they get married. Therefore, the government has instituted a spousal credit that in effect stands in for the basic amount that the “supported spouse” will not be claiming personally. If the stay-at-home spouse makes money, but stays under the basic personal amount, that credit claim is reduced pro rata for each dollar the supported spouse earns.
The federal basic personal amount and the spousal credit were brought in line with one another for the 2007 tax year, but in many provinces the disparity between the provincial basic personal amount and the spousal amount remains.
Where the supported spouse has taxable dividend income, the supporting spouse may elect to report those dividends as his or her own. In addition to increasing the spousal credit, the supporting spouse will be able to claim the related dividend tax credit. As all of the dividends must be included in the election, it will be necessary for the spouses to compare the results with and without the election to see whether it is worth proceeding.
There are a number of other tax credits that can be transferred to a working spouse so that they will not be left unused:
Strategically combining credits
Some credits based on receipted payments may be combined by spouses in order to maximize their tax credit value.
A tax credit is available for medical expenses above a minimum threshold which is the lesser of a set dollar figure ($1,963 in 2008) and 3% of an individual’s net income. By combining the expenses for oneself, a spouse and eligible dependants, the threshold may be reached sooner. Furthermore, the claim period is any 12 months ending in the tax year and therefore the decision to combine must be considered in conjunction with that date choice.
Qualifying charitable donations entitle an individual to a tax credit from the very first dollar, but the value of the credit is greater once donations exceed $200. The 2008 federal credit rates are 15% below that threshold and 29% above it, and provincial credits are similarly applied in two stages. Spouses are allowed to combine their donations made in the tax year to break through that threshold and access the higher credit rates sooner.
Sharing the burden
Of course it’s not all good news. Many tax credits have a policy purpose of assisting individuals and families of modest income, with those credits lost or clawed back if net income exceeds stipulated levels. Though such credits are applied for and paid on an individual basis, that individual must disclose the combined net family income of the two spouses to determine whether the income threshold has been reached. Key credits that can be reduced include:
It is important to know that your client has an obligation to notify the CRA if there is a change in circumstance, such as the start of a spousal relationship that may affect entitlement to these types of benefits, particularly the CCTB.
In the investments arena, the source of funds is critical to the determination of who gets the tax bill. If a spouse transfers assets to the other spouse, the tax on any income from those assets (including capital gains) is attributed back to the original investor. However, it may be possible to get around these attribution rules if the receiver spouse gives a fair market value asset in exchange, pays prescribed interest, invests in a business, or reinvests the income to earn second-generation income. This method, though, is quite complex and advisors should talk to a tax expert for further details.
On the home front, each individual is entitled to make use of the principle residence exemption to protect the capital gains on one’s home from being taxed. Once you become a spouse, the exemption must be shared between the two individuals such that only one property can be protected for any given year, even if each owns a separate property. In fact if spouses each carry a property out of a marriage (ie., on separation), a subsequent exemption claim by a husband on his property extinguishes the wife’s ability to claim an exemption on her property for the years the properties were concurrently owned within the marriage.
Later years and into the beyond
A more recent, and useful, development in spousal-related tax law is the ability to split pension income. Spouses may now annually elect to split as much as 50% of eligible pension income. The optimal split will drive income into lower tax brackets, reduce old age security clawbacks, preserve age credit entitlement and possibly double-up access to the pension credit.
Couples can also make contributions into a spouse’s RRSP in a forward-thinking plan for facilitating later income splitting in retirement. There are even rules that allow a post-mortem contribution to be made from a deceased spouse into a surviving spouse’s RRSP. This is in addition to the ability to rollover RRSP and RRIF plans to a spouse at death to keep growth and income in a tax sheltered zone. As well, when the new tax-free savings accounts (TFSAs) become available in 2009, the proposed rules will also allow rollovers to spouses at death.
During their lives and at death spouses can generally transfer capital property to one another directly or via a trust without triggering inherent capital gains. For optimal benefit, a deceased spouse’s will might create a testamentary trust that enjoys both the rollover and reduced future taxes through graduated bracket treatment for as long as the surviving spouse may live.
Doug Carroll, JD, LLM(Tax), CFP, TEP, is assistant vice-president, taxation & estate planning, at AIM Trimark Investments in Toronto. Doug.Carroll@aimtrimark.com