Income splitting, part 2 – some alternatives

While I’ve recently explained how income-splitting benefits relatively few people and excludes a large number of couples (and, of course, all singles), I think it’s worth addressing a few issues in our tax system where things could be improved for couples.

As a single person, I’m usually indifferent about tax saving measures for couples – generally speaking, our tax system favours couples (I’ll explain a few ways it does this below) over singles, which to me is inherently unfair as it basically confers a benefit on people for choosing to be in a relationship, neglecting those of us who choose not to.  It puts being single on par with being a smoker or a drinker.

That said, I recognize that some (though, from what I’ve seen, fewer and fewer) couples do act together as an economic unit.  It’s interesting seeing the various different arrangements couples have – as someone who takes a keen interest in taxes and personal finance I’ve had lots of discussions about this.  Some couples combine everything, putting everything in both of their names from bank accounts to investments to homes and cars.  Others (from what I’ve seen this seems to apply more to younger couples and couples who have chosen to remain unmarried, as well as same-sex couples, than it does to older married opposite-sex couples) choose to keep things separate, often going as far as keeping everything in their individual names and agreeing to compensate partners whenever a tax benefit is conferred from one partner to the other.  Most couples are somewhere in between this – though the trend (based on my completely unscientific experience) seems to be moving away from joint-everything and towards individual personal finances.

Regardless, however, the point is that some couples do still operate together by keeping everything (or many things) jointly.  And for these couples, who come from all different cultural, ethnic, and income groups (unlike the couples that will benefit from income-splitting), there are a few things in our tax system that don’t make a whole lot of sense.

Refund-payable couples

One big problem a lot of couples experience is the way our tax filing systems work.  While I support having individual tax returns for each partner, this sometimes leads to unintended results.  It’s not uncommon for one spouse to receive a substantial refund while the other has a substantial payable.  This means that, while the family as a whole is getting a net refund (or has only a small payable), one partner has to cut a cheque to the Receiver General, and the other will get a refund cheque later on.  This is very common where one partner is self-employed and the other is not.  For couples that pool their financial resources, this often means laying out cash they don’t have and then getting back a big cheque later that more than covers the difference.  This can be a big deal for low-income couples – often they will simply wait for the refund to come and then pay the balance owing (plus interest) because they don’t have the cash available at all.

In Quebec (which administers its own tax system), there is some opportunity for couples to choose to transfer refunds to partners.  It’s very limited, and applies only when a refund is receivable by at least one partner.  If the federal government were to adopt something like this it could allow (but not require) the partner receiving the refund to forego some of their refund to prevent the other partner from having to write a cheque.  From a family cash flow perspective, this makes drastically more sense than the current system and doesn’t give a financial advantage to couples, it just simplifies the system and helps those families that need it deal with cash flow shortages.

Losses

Losses for tax purposes, for individuals, tend to be fairly uncommon.  The most common situation where I’ve seen this is where someone has a business (usually a new business) that is losing money and has no other income in the year.  For a single individual, this usually means they’re borrowing money to finance their business’ startup, or living off of savings.  The current rules allow losses to be carried back up to 3 years against previous years’ income (reflecting the potential that the losses are being funded by recent savings), and forward up to 20 years against future income (reflecting the potential that the losses are funded by borrowing, which will be repaid with future income).  This makes sense for singles, since it’s unlikely there are other sources of cash for us.

For couples, though, it’s quite common that these losses are funded by the other partner who is either employer or self-employed and earning income.  While in legal form and in reality the business losses are those of the partner running that business, the more likely scenario is that the income-earning partner is the one who’s really funding those losses – whether it’s by paying for the loss-incurring partner’s personal expenses, or directly funding the business.  It seems somewhat unfair that someone would be able to effectively invest in a loss-incurring venture without that being recognized in their taxable income (ever).  There are, of course, ways to set up a business using certain legal structures to (at least indirectly) have some benefit recognized – but this is much more complicated than it needs to be, and there are often other arguments and disadvantages to these structures.

I would propose that while income-splitting might not be advantageous to the typical Canadian (or fair, on a broader perspective), allowing (but, again, not requiring) loss transfers would be useful to reflect the realities of these situations.  I recognize this likely affects very few people – but it can be really frustrating to see a family barely scraping by on a combined net income of $20K per year and paying taxes as if they were earning a lot more since the losses of one partner don’t get reflected right away.  There are already rules in place that prevent or limit abuse (like people running fake “businesses” just to claim losses), so I see no good reason to disallow spousal loss transfers.

Some existing measures

This won’t be a comprehensive list, and these things don’t apply to all couples, but there are already some measures in place that allow couples to benefit from being married:

  • A recent measure was pension income-splitting.  This works similarly to regular income-splitting, but applies only to pensions.  Basically, if one partner is earning pension income and the other isn’t, or is earning less, some of the pension income can be transferred.  This allows couples to double the pension income credit, and also to benefit from differing tax brackets if they exist.  As with regular income-splitting this generally only benefits couples with significant income differentials – and essentially allows people who are married (or common-law, I’ll used “married” to mean both here) to pay fewer taxes simply because of that fact.  Hardly seems fair to me.
  • As I mentioned in my HST post, couples got an HST transition benefit of $1,000, where singles each got $300.  $300 x 2 does not equal $1,000.  This might have been intended to reflect HST paid for children’s things, but childless couples got the $1,000 too.  Yeah.
  • Married individuals have access to their partner’s basic personal amount.  Federally, the first 10,382 of income is effectively tax free as it’s taxed at 15% and everyone receives a credit of 10,382 multiplied by 15%.  If your partner has less than 10,382 of income, you get whatever part of this credit they don’t use.  This is further support for the argument against income-splitting – a family earning less than $20,764 combined is already not paying any tax at all.  If they were two single people, and one earned all of that income, that single person would pay tax.
  • Married individuals are also allowed (but not required) to claim a number of their spouse’s credits (or either spouse may be allowed to claim a credit where an unmarried individual would have no such option), including:
    • Public transit passes, children’s fitness amount, home buyers’ amount, and adoption expenses.  For all of these, the credit amount remains 15% regardless of who claims the credit – having it on one partner’s return or the other generally has no impact on the amount of actual benefit (unless one spouse was already not paying taxes, in which case the other one is getting a credit the other wouldn’t have already gotten).  This is sometimes an easy way to minimize the impact of one partner with a payable and the other with a refund, by simply claiming the credits in the payable-partner’s return.  (This doesn’t always work exactly this way– don’t try any of these things without a professional!)  Except in those situations where one partner is earning relatively little, there’s no actual decrease in the couple’s combined taxes, so I don’t really see this as a major advantage or disadvantage – if anything it’s a reasonable advantage which helps balance a couple’s cash flows without giving them extra cash.
    • Medical expenses – since medical expenses can only be claimed when they exceed a certain threshold of the taxpayer’s income, couples benefit from this by having two people’s expenses combined together on one person’s return – often this is claimed on the lower income spouse’s return to maximize the benefit.  Where two unmarried individuals might not have enough expenses to claim the credit at all, a couple might actually receive a substantial credit for these.  Not that I want to deny people the benefit of a medical expense credit (I disagree with there being a threshold to begin with), but it hardly seems fair that being married means you get to benefit where a single person doesn’t.  It’s not like there’s really much of an option to incur joint expenses (2-for-1 medical procedures?) here – with health insurance being the one notable exception.
    • Tuition amounts – spouses can transfer their tuition credits to one another, if and only if the spouse who actually incurred the expense can’t use it to reduce their taxes.  This is one I actually agree with – if the in-school spouse isn’t using their tuition credits it likely means the not-in-school one is paying for it.  This is similar to the ability to transfer tuition credits to parents who are funding their child’s education.  If the point of tuition credits is to encourage people to pay for education, it seems fair that the person paying for it should be able to receive the credit if the one using it doesn’t need it.
    • Charitable donations – after the first $200 of donations, a preferential credit rate is applied to donations made.  Combining spouses’ donations means this threshold is hit quicker.  This basically can save spouses at most about $40 or so per year (depending on the province), which is really not very much to worry about.  Moreover, any excuse to encourage people to donate to charity is fine by me – though I do wish it were more equitable between singles and couples.

If anyone can think of other areas where couples benefit over singles, or where we could treat couples and singles more equitably, please comment below!

*As always, none of this should be relied on for tax advice – you should always consult a tax professional if you’re trying to do some tax planning.  This is intended merely to explain some of my support / objections for tax measures for couples.

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