LOCK IN LOW RATE LOANS BY JUNE 30, 2022

HOW IT WORKS

An individual cannot simply give a large sum of money to their spouse or minor children to invest because the attribution rules generally make the income taxable to the gift giver. To circumvent attribution, an individual can consider loaning the money to their spouse to invest instead of gifting it. As long as the borrower meets all requirements, including paying the lender interest at the prescribed rate by January 30th after the end of the calendar year, attribution should not apply.

The following scenario illustrates how a spousal loan may be utilized to split income and avoid attribution. Please note that Raymond James, its employees and advisors cannot, and do not, provide legal or tax advice. Potential considerations and strategies contained in this memo are high-level and solely for informational purposes. The following is not legal, accounting or tax advice or a review of all relevant documents, applicable law or details. Individuals may choose to use the information conveyed as a basis for discussion with their own team of professionals in order to obtain legal and tax advice and determine suitability.

EXAMPLE

Ray is a high income earner who pays tax at the highest federal and provincial rates. Ray’s spouse, Jamie, works part-time and pays taxes in a much lower tax bracket. Ray recently received a large inheritance and wants to minimize taxes on investment income. To split investment income with his spouse, Ray wants to loan $500,000 to Jamie.

Before June 30, 2022:

1. Jamie opens a separate taxable investment account to keep the loan funds separate from other investments. Clients can add a Raymond James account to an existing Client ID so that the new account has a “-1” extension on the account
   
   
2. Ray and Jamie sign a promissory note drafted by their lawyer, which indicates the $500,000 loan is payable 30 days after demand, at an interest rate of 1% payable on January 30th each The note may also state that Jamie has the right to repay the loan at any time without notice or penalty.
   
   
3. Ray deposits $500,000 in cash to Jamie’s new
   
   
4. Jamie pays Ray $5,000 interest on or before January 30th the following year (or the calculated pro-rata interest if the loan is outstanding less than a year).
   
   
5. On Ray’s tax return, Ray includes $5,000 interest income from Jamie; Jamie deducts $5,000 interest expense (or pro- rata interest) in the year the interest was paid. Jamie reports all income earned and gains realized on the investment loan account as reported on the Raymond James tax
   
   
6. This loan arrangement can continue indefinitely until Ray demands payment or one of them passes

If they set up the loan when the prescribed rate is 2%, then Jamie will have to pay $10,000 interest annually and Ray will have to include $10,000 in income annually, thus reducing the income splitting effect.

To ensure the income splitting meets legislated requirements, the money should be transferred to an individual account (not joint) and interest paid on schedule by the borrower. Keeping a separate account makes it easier to trace receipt of funds and interest payments made. Careful tax planning is required when loaning assets other than cash because the loan will trigger dispositions at fair market value resulting in reportable gains and possible superficial losses. The recipient spouse should also understand that the funds, are meant to stay invested and are not to be used for spending.

Talk to us if you would like to set up a new account and take advantage of this income splitting opportunity.