Proposed amendments to the Income Tax Act were released today which include the “Family Tax Cut”. The media is reporting this as an income splitting proposal. I’ve reviewed the amendments and I think at most I would call it simulated income splitting. In simplified terms, here’s how it works.

The Family Tax Credit is a limited tax credit for couples with young children and unequal incomes. You’re eligible for the credit if (i) you have an “eligible relation” – basically a Canadian resident married or common law spouse whom you’re not separated from, (ii) you have a child under 18 that lives with you or your eligible relation (and presumably with both of you since you’re not separated), (iii) you’re resident in Canada, and (iv) you didn’t spend 90 days or more in prison (!).

If you’re eligible, you run through the following steps:

Step 1. Calculate the combined tax liability for you and your spouse. (A)

Step 2. Now calculate the adjusted combined tax liability for you and your spouse, as though the higher income spouse had transferred enough income to the lower income spouse to equalize their taxable incomes, to a maximum of a $50,000 transfer (i.e. an income differential of $100,000). (B)

Step 3. If the difference between combined tax (A) and adjusted combined tax (B) is greater than $2,000, the higher income spouse gets a tax credit of $2,000. If (A) – (B) is less than $2,000, the credit is the amount of the difference.

So for eligible spouses, their respective taxable incomes aren’t changed in the end, and your applicable marginal tax rates will be the same. Instead, the higher income spouse simply gets a tax-reducing credit (up to $2,000) to simulate the effect of income splitting.

Given the limited scope of these proposals, structuring where possible to achieve actual income splitting will remain important for high income earners.