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Income splitting is a dangerous tax game if you don’t know the rules

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If you don’t understand the complex rules surrounding what is and isn’t allowed in income splitting, you could find yourself facing off against the tax man in court.Brent Lewin/Bloomberg

With top marginal tax rates over 50 per cent in seven out of ten provinces, the temptation to shift income from a higher-income family member to a lower-income spouse, partner or child has never been greater. Indeed, the spread between the top rate (over 53 per cent in Ontario) and the lowest rate (as low as 20 per cent in B.C. and Ontario) has created ripe opportunity for income splitting. But beware, because if you don’t understand the complex rules surrounding what is and isn’t allowed, you could find yourself caught by the attribution rules or, worse still, facing off against the tax man in court, a route one taxpayer recently tried.

Income splitting can be formally defined as transferring income from a family member to a lower-taxed family member to reduce the overall tax burden of the family. Since our tax system has graduated tax brackets, by having the income taxed in the lower-income earner’s hands, the overall tax bill of the family can be reduced.

Our Income Tax Act has a variety of anti-avoidance rules meant to block attempts at income splitting. These are technically known as the attribution rules because they attribute the transferred income back to the original source, or the transferor.

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