How to Reduce Taxes for High Income Earners in Canada

Canada’s progressive tax system means higher-income earners face a substantial tax burden. Understanding legitimate strategies to reduce this obligation is beneficial. This article explores several approaches to help high-income individuals manage their tax liabilities effectively within the Canadian framework.

Optimizing Personal Deductions and Credits

High-income individuals can significantly reduce their taxable income by strategically utilizing various personal deductions and credits. These provisions directly lower the amount of income subject to tax or reduce the final tax payable.

Registered Retirement Savings Plan (RRSP)

Registered Retirement Savings Plan (RRSP) contributions offer a direct deduction from taxable income, providing immediate tax relief. Funds within an RRSP grow on a tax-deferred basis. The annual contribution limit for 2025 is $32,490, increasing to $33,810 for 2026, or 18% of earned income from the previous year, whichever is less, plus any unused contribution room. Spousal RRSPs allow one spouse to contribute to the other’s plan, enabling future income splitting during retirement.

Child Care Expenses

Child care expenses paid to eligible service providers can be deducted from the income of the lower-income spouse. This deduction helps families with young children reduce their taxable income, recognizing costs associated with earning employment or business income.

Medical Expense Tax Credit (METC)

The Medical Expense Tax Credit (METC) provides a non-refundable tax credit for significant out-of-pocket medical expenses. To qualify, eligible medical expenses must exceed the lesser of 3% of the taxpayer’s net income or a specific threshold, such as $2,759 for the 2024 tax year. This credit can be claimed for a 12-month period ending in the tax year.

Charitable Donations

Charitable donations offer a non-refundable tax credit at both federal and provincial levels. The federal credit is 15% on the first $200 of donations and 29% on amounts exceeding $200. For individuals in the highest tax bracket, the federal credit rate can reach 33% on donations above $200. Pooling donations with a spouse or carrying forward donations for up to five years can maximize the credit.

Employment Expenses

For employees, certain employment expenses can be deducted if required by the employer and documented on Form T2200, “Declaration of Conditions of Employment.” These expenses can include office supplies, travel, or a portion of home office costs, provided specific conditions are met and expenses are not reimbursed by the employer.

Other Deductions and Credits

Other deductions and credits can also contribute to tax reduction. These might include professional membership dues required for employment, or carrying charges on investments, such as interest paid on money borrowed for investment purposes, provided specific income-earning criteria are met.

Leveraging Tax-Efficient Investments

Structuring investments strategically can significantly minimize tax liabilities on investment income and capital gains for high-income earners. The choice of investment vehicle and the type of income generated play a substantial role in overall tax efficiency.

Tax-Free Savings Accounts (TFSAs)

Tax-Free Savings Accounts (TFSAs) are a powerful tool, allowing investment income and capital gains to grow and be withdrawn completely tax-free. Contributions to a TFSA are not tax-deductible, but all earnings within the account are exempt from tax. The annual contribution limit for a TFSA is $7,000 for 2024.

Registered Retirement Savings Plans (RRSPs)

Registered Retirement Savings Plans (RRSPs) offer long-term tax deferral benefits. Investments held within an RRSP grow without annual taxation, allowing for compounding returns. The tax saved from RRSP contributions can be reinvested, further accelerating wealth accumulation. Strategic withdrawals in retirement, potentially in lower income years or through income splitting, help manage the eventual tax liability.

Capital Gains

For non-registered investment accounts, understanding the tax treatment of different income types is important. Capital gains, which arise from selling an investment for more than its purchase price, receive preferential tax treatment. For individuals, only 50% of a capital gain is included in taxable income. Strategies like tax-loss harvesting, which involves selling investments at a loss to offset capital gains, can further reduce taxable income.

Eligible Dividends

Eligible dividends received from Canadian corporations are generally taxed more favorably than interest income due to the dividend tax credit. This credit aims to prevent the double taxation of corporate profits. Eligible dividends are “grossed up” for tax purposes, and a corresponding federal and provincial tax credit then reduces the tax payable.

Interest Income

Interest income, by contrast, is fully taxable at an individual’s marginal tax rate, making it generally the least tax-efficient form of investment income for high-income earners in non-registered accounts.

Interest Paid on Borrowed Money

Interest paid on money borrowed to invest in income-producing assets can be deductible, provided certain conditions are met. The loan must be used to acquire property that has a reasonable expectation of earning income, such as dividends or interest. This strategy allows for a reduction in taxable income by offsetting investment income with the cost of borrowing.

Implementing Income Splitting Techniques

Income splitting involves strategically shifting income from a higher-income family member to a lower-income family member to capitalize on lower marginal tax rates.

Spousal RRSPs

Spousal RRSPs are a key tool for future income splitting. Contributions to a spousal RRSP are deductible by the higher-income spouse, but the funds belong to the lower-income spouse. When the lower-income spouse withdraws funds in retirement, the income is taxed in their hands, often at a lower marginal rate. This strategy shifts future taxable income to the spouse expected to be in a lower tax bracket during retirement.

Spousal Loans

Spousal loans, structured as prescribed rate loans, offer another method for income splitting while adhering to attribution rules. A higher-income spouse can lend money to a lower-income spouse at the CRA’s prescribed interest rate. The lower-income spouse then invests these funds, and any investment income earned in excess of the prescribed interest is taxed in their hands. This technique allows investment income to be taxed at the lower-income spouse’s marginal rate, provided the loan’s interest is paid annually.

Pension Income Splitting

Pension income splitting allows eligible pension income to be shared with a spouse or common-law partner for tax purposes. Up to 50% of eligible pension income can be allocated to the lower-income spouse. This election is made jointly by both spouses and can significantly reduce the higher-income earner’s tax liability. Eligible pension income typically includes payments from registered pension plans and, for those aged 65 or older, income from Registered Retirement Income Funds (RRIFs) or annuities.

Family Trusts

Family trusts can serve as a sophisticated vehicle for income splitting, particularly for investment income. A family trust can hold assets, and the income generated can be distributed to beneficiaries, such as adult children, who are in lower tax brackets. This allows the income to be taxed at the beneficiaries’ lower rates rather than the higher marginal rate of the individual who originally earned the capital to fund the trust.

Attribution Rules

A thorough understanding of the Canada Revenue Agency’s (CRA) attribution rules is essential when implementing any income splitting strategy. These rules, found in the Income Tax Act, are designed to prevent taxpayers from artificially reducing their tax by transferring income-producing property to a spouse or related minor. Generally, if property is transferred or loaned to a spouse or a minor child, any income (and capital gains for spouses) generated from that property may be attributed back to the original transferor. However, specific exceptions, such as the prescribed rate loan, allow for legitimate income splitting when properly structured.

Strategic Use of Corporate Structures

For high-income earners who are business owners, professionals, or those with significant self-employment income, incorporating a business can offer substantial tax advantages.

Retaining Profits within a Canadian Controlled Private Corporation (CCPC)

Retaining profits within a Canadian Controlled Private Corporation (CCPC) allows for the deferral of personal tax until funds are paid out to the shareholder as salary or dividends. The corporation pays tax on its profits at corporate rates, which are often lower than an individual’s top marginal tax rate. This deferral allows funds to grow within the corporation, potentially being reinvested in the business or other assets, before being subjected to personal tax.

Small Business Deduction

CCPCs benefit from the small business deduction, which applies a significantly lower corporate tax rate to active business income up to a certain threshold. Federally, this rate is 9% on the first $500,000 of active business income. Provincial rates further reduce the overall corporate tax burden on this income, with some provinces having a small business rate as low as 3.2% on the first $500,000.

Lifetime Capital Gains Exemption (LCGE)

The lifetime capital gains exemption (LCGE) is another significant benefit available to shareholders of qualified small business corporation shares. This exemption allows individuals to realize a certain amount of capital gains from the sale of such shares completely tax-free over their lifetime. For 2025, the LCGE limit is proposed to increase to $1.25 million of eligible capital gains. Incorporating a business can facilitate meeting the criteria for this exemption, providing a substantial tax-free payout upon business sale.

Holding Companies

Holding companies can play a strategic role in corporate structures. A holding company can own shares of operating companies, allowing for the transfer of funds between related corporations without immediate tax consequences. This structure can be used for asset protection, to consolidate passive investments, or to facilitate inter-corporate dividends. Dividends paid from an operating company to a holding company are generally tax-free, allowing for efficient movement of funds within a corporate group.

Salary vs. Dividends

Salary payments are deductible by the corporation, reducing its taxable income, and create “earned income” for the shareholder, which generates RRSP contribution room. Dividends, on the other hand, are not deductible by the corporation but benefit from the dividend tax credit at the personal level. This aims for tax integration where the combined corporate and personal tax on distributed profits approximates the personal tax if the income were earned directly. The optimal mix often depends on the individual’s income needs, current tax rates, and future financial goals.

Passive Income Rules

If a CCPC earns significant passive investment income, its access to the small business deduction may be reduced. If a corporation’s passive income exceeds $50,000 in a taxation year, the small business limit of $500,000 begins to be phased out, potentially eliminating the lower tax rate once passive income reaches $150,000.