Politics

Income splitting: What it is and who benefits

Prime Minister Stephen Harper has announced an income-splitting proposal, fulfilling a promise from the 2011 election campaign.

Prime minister announces a capped tax break on family incomes to fulfill an election promise

Prime Minister Stephen Harper does arts and crafts with a student at the Joseph and Wolf Lebovic Jewish Community Campus in Vaughan, Ont., on Thursday after announcing his government's income-splitting proposal. (Nathan Denette/Canadian Press)

During the 2011 election campaign, Prime Minister Stephen Harper promised that if he was re-elected his government would allow families with young children to be able to shrink their tax burden by splitting parents' incomes for tax purposes.

On Thursday, he announced "the family tax cut," which, when passed, would apply to the current tax year. It is a non-refundable credit of up to $2,000 for couples with children under 18 years.

What did Harper promise in 2011 on income splitting?

In 2011, the plan was to allow families with children under 18 to split a household income of up to $50,000, once the federal budget was balanced. That means, for example, that in a family with a stay-at-home spouse or someone working part-time, the partner with the larger income could assign up to $50,000 of income to the lower earner for tax purposes.

Harper argued that Canada's income tax system "treats families the same as roommates living under the same roof with no financial attachment. That is not realistic. That is not fair."

The 2011 Conservative Party platform says income-splitting will provide "significant tax relief for approximately 1.8 million Canadian families — each of them saving, on average, $1,300 per year."

What is the federal government now proposing?

The only major change to the new promise is that there is now a $2,000 cap on the maximum benefit a family can earn from income splitting.

That means the average saving will be less than the $1,300 average the party promised. But, along with income splitting, the government will also increase the universal child-care benefit and the child-care expense deduction, which means families with children will save an average of $1,140 per year in taxes, the government says.

How much will it cost?

The Department of Finance says this income-splitting proposal will cost the treasury about $2.4 billion in foregone revenues in the current fiscal year, and an average of about $2 billion per year over the next five years.

Who benefits from the family tax cut proposal?

Only families with children under 18 with two parents in different tax brackets would benefit.

The C.D. Howe Institute reports that 85 per cent of all households will receive nothing from new measure, as they don't fit the criteria.

As for families, the Conservative Party estimates that 1.8 million families will benefit from income splitting, a figure that the Broadbent Institute agrees with.

The institute, however, estimates that 543,000 families would have received a benefit of $2,000 or more under the 2011 proposal. Under the new family tax cut, those families will receive $2,000, the maximum benefit.

The average benefit for the nearly four million families with children under 18 will be $524 in 2015 under the family tax cut, which can be calculated by using data provided in the Broadbent Institute report.

Shortly before he died earlier this year, former Conservative finance minister Jim Flaherty was asked about his party's income-splitting proposal.

"I'm not sure that overall it benefits our society," he said.

How do benefits vary from province to province?

Sixty-one per cent of Quebec families with children under 18 would see no benefit at all, compared to 44 per cent in Alberta, according to the Broadbent Institute. That is primarily because of the different family makeups and income levels in the two provinces.

Capping the benefit at $2,000 affects 23 per cent of Alberta families with children under 18, compared to seven per cent in Quebec, according to the institute's data.

What are the arguments for income-splitting?

Under Canada's progressive income tax rates, if two families have the same total income, a family with two parents earning around the same amount will pay less tax than a family with two parents earning very different amounts.

"The main reason to implement income splitting is to establish tax fairness," the Institute of Marriage and Family Canada's chief executive Andrea Mrozek told Parliament's standing committee on finance earlier this month.

Mrozek argues that "fixing this inequity can be done either through income splitting or by flattening the tax brackets."

For Lawrence Solomon, executive director of Energy Probe, one reason to support income splitting is for its social impact. "Because incentives do matter, many of those now involuntarily stuck in that single household demographic would migrate to married status."

Proponents often point out that income splitting has been available to couples in the U.S. since 1948. Uncle Sam allows married couples to file jointly or individually — the choice is theirs, depending on which way will save them the most tax. The vast majority of couples elect to file jointly.

What are the criticisms of the family tax cut?

For the Boadbent Institute, the proposal is "fundamentally unequal." Rick Smith, the executive director, says "the greatest benefits would still go to the highest income earners with stay-at-home spouses, but would do little for low-income families" or single-parent families.

Liberal Leader Justin Trudeau said income splitting "doesn't make sense," and he will reverse the tax cut if elected. After Harper's announcement he said the proposal "would give a tax break to families like mine or Mr. Harper's. That's not good enough."

Opposition leader Thomas Mulcair didn't answer directly on Thursday whether he would roll it back if elected prime minister. But he did say, "It will only help a very small minority of people at a time when inequality is increasing in our society after years and years of Liberal and Conservative rule."

How does pension income splitting compare to the family tax cut?

For pensioners, it's the actual income that's split. That income can be from life annuity payments, from a company pension plan, annuity payments from an RRSP or deferred profit-sharing plan, RRIF payments and even the Canada Pension Plan.

For example, with the CPP, if a couple opts for income splitting and one receives $700 a month and the other receives $200, they can both receive a $450 monthly cheque. They must both be at least 60 years old.

The split can sometimes reduce or eliminate the clawback on Old Age Security payments or the age credit for the higher-income spouse. Further tax savings appear if both partners can claim the $2,000 pension income credit.