Tax-Effective Spending Strategies
By Arthur Drache

What you earn minus what you spend equals what you have left over to invest. Just as there are tax-efficient earning strategies, there are tax-efficient spending strategies.

With two-earner couples now the norm rather than the exception, investment income often tends to accrue to the higher-income earner, primarily because he or she is the one with the most disposable income to invest. But good tax planning suggests that the ideal situation is for investments to be in the hands of the lower-income earner in order to reduce the tax bite on investment returns.

Of course, the main problem is that the Income Tax Act contains several rules that are designed to limit the benefits of this sort of planning. Most notable of the provisions are the income attribution rules. They require that, in cases where one spouse has transferred (either by gift or by way of a low-interest loan) property to the other spouse, the spouse who makes the transfer pays tax on the income generated by the transferred amounts.

Tax planners have for generations developed techniques to avoid these rules or at least limit their impact. These include setting up income-splitting corporations, hiring a spouse, and making loans at acceptable rates of interest.

But there are simpler ways that family spending and tax filing practices can result in investment capital in the hands of the lower income spouse.

Consider this situation: Michael, a 60ish lawyer, has annual income well in excess of $100,000 a year and expects to be earning at this level for at least another 10 years. His investment portfolio is growing substantially now that the house is mortgage-free and the kids are on their own. Deborah, his wife, was a middle-level civil servant who had been earning about $70,000 a year but was forced into retirement a couple of years ago. She now has an annual pension of about $30,000, augmented by some consulting that can produce between $5,000 and $10,000 a year, after expenses.

Because Deborah’s income was always substantial, if not up to Michael’s, they more or less split the day-to-day living costs. But, aside from her pension contributions, Deborah didn’t do any investing.

Now, the couple realizes that it would be in their interest for Deborah (as the lower-income earner) to invest her disposable income even if it means that Michael has to spend more on ordinary living expenses.

They have adopted the following rules:

1. All non-deductible expenses are paid by Michael.
2. Deborah claims all tax credits where available, such as charitable and medical credits, taking care that she does not claim so much as to "waste" them by claiming credits in excess of her tax liability.
3. When Deborah does some consulting work that draws additional tax liability, Michael pays her taxes.

By taking this route, Deborah ends up with virtually her entire annual gross income available for investment without getting involved in any fancy tax planning that requires the creation of trusts, corporations or loans. Michael’s disposable income drops and he has less to invest which, in the context of this family, is quite acceptable.

Deborah and Michael no longer have a single joint bank account, but keep separate accounts so that the source of funds can be easily traced if questions are raised. Thus, Deborah’s pension flows into her own account and investments are make in her name by debiting that account.

While the example we have used is that of an older couple, the same broad techniques can be used for younger people as well -- although experience shows that in cases when there is less disposable income and more emphasis on a couple’s sharing of costs, there is often resistance.

It is worth pointing out that parents and relatives can help in this sort of planning. When the couple’s marriage is strong, major gifts and inheritances can be directed solely to the lower-income spouse (and deposited in his or her account), again with the goal of increasing capital for investment purposes.

The moral is that good tax planning does not always require high levels of sophisticated legal work. All that is necessary is an understanding of how the tax system works, discipline, and the passage of time.

Copyright 2001 by Arthur Drache. All rights reserved.

This article was prepared by Terry Fay who is an Investment Advisor with Dundee Securities Corporation, a DundeeWealth Inc. Company. This is not an official publication of Dundee Securities and the author is not a Dundee Securities analyst*. The views (including any recommendations) expressed in this article are those of the author alone, and they have not been approved by, and are not necessary those of Dundee Securities.

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