Taking Advantage Of Tax Brackets

If you are currently married and have non-RRSP investments, you may be paying more than you need to be on any income produced by these investments.

To illustrate, let's look at two fictitious couples - the Smiths and the Does.

In the Smith family, Jack is currently working and earned an income of $50,000 in 1999 while Jill is operating a small home-based business which provided her with a taxable income of $6,000 in 1999.

A couple of years ago, they decided to start saving for a major trip and currently have $10,000 invested in a money market fund that earned a total of $400 in interest last year.

The Does' case is quite similar, Jane Doe is currently working and earning an income of $50,000 while her husband John Doe is operating a home-based business in which he too has a taxable income of $6,000.

The Does' also have been saving for a trip and currently have $10,000 invested in a money market fund which also paid out $400 in interest last year.

However this is where the similarity ends.

When both couples completed their 1999 tax returns, as a family, the Smith's ended up paying $168 more in income tax than the Does.

The reason for this discrepancy is in the source of the funds used to build up the money market fund each couple is using to save for their respective trips.

In the Smiths' case, a couple of hundred dollars was directed from each of Jack's paychecks to the travel fund, while Jill used the money from her business to pay for a number of household expenses, including utilities and groceries.

For the Does, John was the one who set up the travel fund and directed income which he earned from his home-based business into this account, while Jane used her income to pay for the household expenses.

When it came time to prepare their tax returns, Jack had to add the $400 in interest earned on the investment on his return while John claimed the $400 in interest made on the Does' travel fund on his return.

Since Jack, based on his income is in a 42% marginal tax bracket, the tax on the $400 of investment interest he earned was $168. John's income, on the other hand, was low enough that he was non-taxable, even with the addition of the $400 in interest. In other words, the $400 that the Does made on their travel fund was tax-free.

If you find yourself in a situation in which one spouse is in a higher tax bracket than the other spouse, the rule of thumb is that the higher income spouse should be paying the all the expenses, while the spouse in the lower marginal tax bracket, should be the one who makes the non RRSP investments.

Doing so will reduce the family's total tax bill and help you retain more of your investment dollars.