Income splitting

Income splitting

Income splitting is a method of reducing a family's income tax in a jurisdiction that employs progressive taxation. In situations where one member of a household earns considerably more than another, they will likely be in a higher tax bracket, and thus have to pay more income tax. Income splitting works by shifting some of the income to the lower earner, and thus shifting the higher earner to a lower tax bracket.

Income splitting is the default behaviour in countries which allow or require spouses to file a joint tax return. Thirteen OECD countries allow such fillings: the United States, France, Germany, Belgium, Greece, Luxembourg, Portugal, Switzerland, Iceland, Ireland, Norway, Poland and Spain.

Income splitting became available explicitly in the U. S. in 1948. Prior to that time, only single filing was permitted. However, couples in community property states such as California had access to "de facto" income splitting since one-half of the income of one spouse could be attributed to the other spouse. This led to equity issues among taxpayers in community property and those in common law states and hastened the passage of "de jure" income splitting.

Joint filling by couples is not permitted in other jurisdictions, and tax laws in these countries generally have regulations preventing the direct transfer of income from one spouse to another to reduce taxes. There are often still methods of using income splitting to reduce taxes in these jurisdictions. For those who own their own company, hiring family members will reduce the overall tax burden by shifting income to a low taxed wage from the higher taxed profits. Having all investments in the name of the lower taxed family member will also allow the tax burden to be reduced.

Income splitting is currently a matter of debate in Canada. Joint fillings have not been permitted in Canada, but the Conservative government of Stephen Harper has mused about bringing them in. In part to mitigate the effects of the government's decision to tax income trusts, finance minister Jim Flaherty introduced income splitting for seniors in 2006.

The primary advantage of income splitting is that it reflects that the household rather than the individual is the basic economic unit. A family with one person earning $100,000 per year and another who doesn't work is no wealthier than a couple where each earns $50,000, yet the former will be taxed at a considerably higher rate due to progressive taxes. The main disadvantage is that it will cost the government several billion dollars per year. An important social impact of income splitting is that in the vast majority of cases where income is greatly unbalanced between a couple, it is because the woman is not working. Canada shifting its income splitting policy would thus amount to a billions of dollars subsidy for this lifestyle, and would have the effect of reducing women's participation in the work force. This effect is lauded by some socially conservative groups, but strongly opposed by feminist advocates. In part because of these concerns income splitting is becoming less common globally, and since 1970 it has been abolished in seven OECD countries.


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