Incomesplitting

Understanding Income Splitting: Top Strategies to Save on Taxes

Key Takeaways

Income splitting is a tax strategy that redistributes income among family members to lower the overall family tax burden.
Families can implement income splitting by hiring family members in a business or transferring benefits like tuition credits.
In Canada, contributing to a Registered Retirement Savings Plan (RRSP) offers a method to practice income splitting.
Alternative strategies to income splitting include using standard and itemized deductions to further reduce taxable income.
It's critical to understand deduction eligibility requirements to avoid overestimating potential tax savings.

What Is Income Splitting?

Income splitting is a legal tax strategy, allowing families to share income to lower their overall tax bill. For example, a higher-income family member can shift some income to a lower-income spouse or child, which can reduce the total taxes the family pays. Learn practical ways to use income splitting, such as RRSP contributions in Canada and tax credit transfers, along with how income splitting can help cut taxable income and save on taxes. We'll also show you tax strategies and key things to watch out for, giving you a complete guide to smart tax savings.

Methods for Lowering Family Taxes Through Income Splitting

An example of income splitting is a higher-income family member transferring a portion of his or her income to a lower-income family member through some legal means, such as hiring the lower-income family member and deducting the cost of the labor as a legitimate business expense. Although the family still earns the same amount of money, the overall amount of tax it must pay is reduced.1

Another example is the transfer of tax credits from a lower-income family member to a higher-income family member. This can be done by transferring tuition credits from students to parents, funding their children's post-secondary education.2

In Canada, an income-splitting technique can be used to reduce tax liability through Registered Retirement Savings Plan (or RRSP) contributions because money contributed to RRSPs is tax-deductible. (RRSPs are special types of investment accounts designed to help Canadians save for retirement. To be eligible for an RRSP, participants must be under the age of 71, have contribution room, and file taxes with the Canadian government.)34

A higher-income family member can contribute to a lower-income family member's RRSP, thus lowering the higher-income person's overall tax liability and potentially moving the higher-income family member into a lower tax bracket.3

Enhancing Tax Deductions with Income Splitting

Several tax deduction options are available to citizens in addition to the income splitting strategy. The two major categories are standard deductions and itemized deductions. In the United States, the federal government gives most individuals a standard deduction that varies by year and is based on the taxpayer's filing characteristics.5

Each state sets its own tax law on standard deductions, with most states also offering a standard deduction at the state tax level. Taxpayers have the option to take a standard deduction or to itemize deductions. If a taxpayer chooses to itemize deductions, then deductions are only taken for any amount above the standard deduction limit.5

When itemizing deductions, it’s important to keep in mind that there may be certain limitations on what you can deduct each year. The IRS sets a threshold amount for many deductions. It’s important to research these prior to filing so you don’t expect to pay less than you ultimately have to.5

Internal Revenue Service. "Publication 535: Business Expenses," Page 8.

Internal Revenue Service. "Publication 970: Tax Benefits for Education," Page 11.

Canada Revenue Agency. "Setting up an RRSP."

Canada Revenue Agency. "RRSPs and Other Registered Plans for Retirement."

Internal Revenue Service. "Topic No. 501: Should I Itemize?"

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