Income splitting a boon to families

Canadians tasted income splitting with pension splitting for seniors. Extending it to families would be an even greater benefit.

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From the June 2014 issue of the magazine.

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When the concept of family income splitting was floated in the 2011 federal election, it had well-proven legs. One specific tax-filing profile got great results: senior couples that split up to 50% of qualifying pension income.

The broader election promise was specific to families with minor children. Couples would split up to $50,000 of taxable income. Which families would most benefit? The answer lies in the progressivity of our tax system: the more you earn, the more tax you pay. So family income splitting helps higher-income households more, which is where criticisms of the proposals start.

For true tax fairness to occur, households in similar circumstances should pay similar amounts of tax on income. Better said, they should have roughly the same after-tax results.

Income Splitting Graph

However, income is not always a true test of ability to pay. It’s possible to have little income but great wealth, as many investors, farmers and landlords may tell you. It’s hard to achieve absolute tax fairness when sources of income and capital are so diverse.

One neighbour may earn employment income while his wife is self-employed. There may be dividend sprinkling from Grandpa’s family trust, and refundable and non-refundable tax credits for their children.

But your other neighbours may be pensioners who are already income splitting, drawing investment earnings from their Tax-Free Savings Accounts—never taxable—while deferring tax on accrued gains in registered and non-registered investments. They may have downsized, enjoying a large tax-exempt gain on the sale of their former principal residence, and claiming significant tax credits for a new disability in the family.

Across the street, a young family with newborn twins may be waiting for their first Universal Child Care Benefits (not income tested) and Canada Child Tax Benefits, where the benefit is based on combined family net income.

When we ask a simple question like who benefits from income splitting, the answer is complex. In some scenarios, the household economic unit as a whole must be taken into account. This raises the question whether our tax system would benefit from broader tax reform; one that taxes the household rather than individuals.

Statistics Canada defines a household as a group of individuals sharing a common dwelling unit, related by blood, marriage/common law or adoption. Stats from 2011 show two-parent families with children under 18 had an average market income of $106,100; an economic family of two people or more earned an average $84,400; Lone-parent families earned an average $39,100.

These figures put the size of actual market income—total income of a household minus government transfers—into perspective. It helps us better answer the key question: Would family income splitting help average families with children?

The answer is a resounding yes, particularly if one spouse has no income and the other earns all of it. As the chart shows, for an Ontario family, savings can reach almost $7,000 a year. Over 25 years, that’s $175,000 a family before investment returns.

From those tax savings $5,500 could be invested annually in a TFSA for the spouse who didn’t work over a 25-year child-rearing period. This stay-at-home spouse ends up with a tax-free retirement fund of $275,624 (based on 5% returns). Since average couples should save $250,000 to $750,000 for retirement, depending on desired lifestyle, that’s enough security to trade work time for more time with family.

Note that the savings shown here chiefly accrue to families with one big income and one much smaller. Low-income families would benefit more by raising the Basic Personal Amount instead.

This may be an issue in the next election. If you believe a simpler tax system is a more compliant one, family income splitting could indeed be a really good thing.

Evelyn Jacks is President of Knowledge Bureau, a national financial educational institute. She tweets @evelynjacks.

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