How to spread the tax liability between spouses?

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By Julie Cazzin with Andrew Dobson

Q: Can I transfer “in-kind” from my brokerage account to my wife’s smaller brokerage account in order to spread the tax liability? If so, what’s the best way to do that? If not, what’s another tax-efficient way to spread the tax liability? — Bruce B

FP Answers: You can transfer assets to your spouse in-kind, but it may not necessarily help your tax situation due to spousal attribution.

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Spousal attribution can apply when you transfer an asset to a spouse such that future income and capital gains are taxable back to you. The rule exists to ensure that a higher-income spouse who transfers assets to a lower-income spouse cannot avoid the higher taxes that come with being in a higher tax bracket.

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Attribution rules also apply between parents and minor children. The main difference is that capital gains realized by a child using gifted money are attributable and taxable to the child. Interest and dividends are taxable back to the gifting parent.

Despite the attribution rules, there are strategies you can employ to help improve your overall family tax efficiency.

First, though you can’t transfer your portfolio to your wife without attribution applying, you can contribute to her registered accounts without worrying about the rule. For example, you can give your spouse money to contribute to their tax-free savings account (TFSA) and registered retirement savings plan (RRSP).

You can also set up a spousal RRSP for which you would be able to deduct the contributions from your income, but your spouse will be able to withdraw in the future based on their tax rates as long as the three-year rule does not apply. If you make a contribution to a spousal RRSP, your spouse needs to wait three calendar years to make the withdrawal without attribution back to you.

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You mention spreading the tax liability for your investments. If one of your concerns is the deferred capital gain on investments you want to sell, Bruce, there could be a benefit to selling over multiple years. But the capital gain would need to be quite large.

If the capital gain on the sale pushes you into a higher tax bracket, that might be one reason to consider being strategic, especially if your capital gains for a single year could exceed $250,000, given the new capital gains inclusion rate of two-thirds for large capital gains. But waiting a year or more to sell an investment you want to sell today risks focusing too much on tax over investment strategy.

Another strategy that has become less popular in recent years due to high interest rates is the use of a prescribed rate loan (PRL) or spousal loan.

The concept of a PRL is that the higher-income spouse “lends” money to the lower-income spouse at the Canada Revenue Agency‘s prescribed rate. This loan allows the lending spouse to shift taxable assets to the lower-income spouse so that they can invest and earn income at lower tax rates.

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It is easy to see the benefit of this strategy when rates are low because the break-even point is more achievable. The loan interest is taxable income for the lending spouse, while the portfolio income (with an applicable deduction for the loan interest) is taxable to the borrowing spouse.

The CRA determines the prescribed rate on a quarterly basis. Prior to the fall of 2022, the prescribed rate was under three per cent for more than a decade, which made it easier to justify the strategy. The prescribed rate is currently five per cent, which makes it less reasonable since the expected returns have to be fairly high for the strategy to make sense.

The prescribed rate when the loan is made can apply forever. If rates fall, this may become a more viable strategy.

In the meantime, Bruce, your wife could save some or all of her income while you use your income to pay some or all of the family expenses. This is a legitimate way to build an investment portfolio in her name over time.

Andrew Dobson is a fee-only, advice-only certified financial planner (CFP) and chartered investment manager (CIM) at Objective Financial Partners Inc. in London, Ont. He does not sell any financial products whatsoever. He can be reached at [email protected].

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