Time to lock in your spousal loan!
For several years now, the prescribed interest rate applied to spousal loans has been set at 1%, but that could change if interest rates rise in 2017. Are you taking advantage of the opportunity to transfer capital to a spouse with a bona fide loan at the current low interest rate?
Spousal investment loans are a means of circumventing the attribution rules and can effectively allow the higher-income spouse to transfer taxable investment income to their lower-income spouse, thereby reducing the total family tax bill. Consider this example:
Martin earns $200,000 annually and has a non-registered investment portfolio of $100,000. Martin’s wife, Eve, has never worked but has her own investment portfolio from capital inherited from her father. Eve’s taxable income is $20,000. The couple lives in New Brunswick.
Assume that Martin were to invest his $100,000 in Government of New Brunswick strip bonds paying 4.544%. His annual earnings on the bonds would be $4,550 on which he’d pay $2,275 income tax, leaving after-tax investment income of $2,275.
If Martin made a bona fide spousal loan to Eve for $100,000 at the current prescribed rate of 1% and she made the investment instead, then Martin would have to include the $1,000 interest from the loan in his income (and pay $500 tax) and Eve would add the net $3,550 (investment interest earned minus interest paid on the loan) to her income, and she would pay $844 tax. The net earnings for the family would be $4,550 earnings, less $500 tax paid by Martin and $844 tax paid by Eve, or $3,206. The net result is an increase in net family income of $931 per year.
However, if the prescribed interest rate goes up by just 1%, the interest on the loan would be $2,000; therefore, Martin’s taxes on the interest from the spousal loan would be $1,000 and Eve’s taxes on the net $2,550 interest would be $595. The net increase in family income would then be $680 – a $251 reduction.
The prescribed interest rate on spousal loans is locked in for the life of the loan, so a loan set up at 1% now will continue to shield against income attribution for as long as the loan is outstanding and interest is paid annually before January 30 of the following year. The terms of the loan should mirror commercial terms to be audit-proof.