Income splitting has not been a terribly easy thing to accomplish in Canada. As a general rule, Canada's tax system requires each individual to report and pay tax on all of the income they earn. The government has been reluctant to allow couples to pool their income because that would lower tax revenues, all other things being equal. That's because Canada has a progressive income tax system. Tax rates go up as someone's income moves up through the various tax brackets, so Ottawa's overall tax bite gets bigger. Pooling would put both partners in the same tax bracket and often lead to a lower combined tax bill.

Finance Minister Jim Flaherty (CBC)

So the announcement on Oct. 31, 2006, that the federal Conservative government would allow senior citizen couples to split eligible pension income as of 2007 attracted a lot of support from seniors groups (although the simultaneous policy change to bring in a tax on income trusts attracted most of the media attention.)

Finance Minister Jim Flaherty has also confirmed that the Harper government is musing about extending income splitting to all couples — not just seniors. This would mark a major departure from current Canadian tax policy.

Are there any income splitting techniques currently allowed in Canada?

As mentioned above, most would-be attempts at income splitting are doomed to failure — short-circuited by the Income Tax Act and its attribution rules. Basically, those rules state that most attempts to transfer income from a higher income spouse to a spouse with little or no income will not be allowed. But there are a couple of situations where income splitting is actually allowed and even encouraged by Ottawa.

The most familiar method of income splitting is the spousal RRSP. That allows a higher income earner to make an RRSP contribution to the partner's RRSP. The contributing partner gets the tax deduction. But the income generated by the RRSP when it matures is taxed in the hands of the lower income spouse. There are special attribution rules here — the main one being that if the funds from a spousal RRSP are withdrawn in the two calendar years after the original contribution was made, the funds will be attributed back to the contributing spouse.

Ottawa also allows seniors to split Canada Pension Plan retirement benefit payments, but it is necessary to apply. Further information on CPP pension sharing is available here.

Another income splitting method involves paying one's spouse or children to work in the family business. That can transfer income away from the higher income spouse to family members who earn less — something that would end up lowering the overall tax bill.

Financial advisors also suggest having the higher-earning spouse pay all the household bills. That could allow the lower-earning spouse to invest most or all of their take-home pay. "Any gains or income from their investments will be taxed at a lower rate," says an advisory from Sun Life Financial. "That means you get to keep more of the earnings instead of paying them to the government in tax."

What about the Tory plan to allow seniors to split pension income?

On Halloween night 2006, Flaherty announced that the government would relax income splitting rules for seniors — senior couples would be allowed to pool their retirement pension income. But there are some specific eligibility rules.

For those age 65 and over, eligible pension income includes lifetime annuity payments under a registered pension plan, an RRSP or a deferred profit-sharing plan, and payments from a RRIF. For those under 65 years of age, eligible pension income is limited to lifetime annuity payments from a registered pension plan and "certain other payments received as a result of the death of the individual’s spouse or common-law partner."

How common is income splitting in other countries?

It's actually quite common in industrialized countries. A 2002 survey of 32 OECD countries by the President's Panel on Tax Reform found that joint filing by married couples is required or allowed in 13 OECD countries (Belgium, France, Greece, Luxembourg, Portugal, Switzerland, the United States, Germany, Iceland, Ireland, Norway, Poland and Spain). But that study also found a trend to having taxpayers file as individuals, rather than jointly. Since 1970, seven OECD countries have changed their tax systems to one based on individual income taxation.

The U.S. has allowed income splitting since 1948. Uncle Sam allows married couples to file jointly or individually — the choice is theirs, depending on which way will save them the most tax. The vast majority of couples elect to file jointly.

Who benefits most and least from income splitting?

The biggest tax savings from unrestricted income splitting take place when one member of a couple has an income in the top tax bracket — over $100,000 a year — and the other is in the lowest bracket. Potential savings could run to thousands of dollars a year.

Of course, we're still talking generalities here. As with most tax policies, the devil is in the details.

Who wouldn't benefit at all from income splitting? Generally speaking, single taxpayers who file individual returns and couples where each earns similar salaries would gain nothing.

That's why the debate over the wisdom of adopting income splitting quickly turns into a question of fairness and social policy.

Independent MP Garth Turner wrote recently that income splitting would be "a tacit acknowledgement that the family, and not the individual, is the basic unit of the economy." Turner supports the idea of wider income splitting, as do those who say the current system penalizes single-earner families. Why should a family where both partners earn $40,000 pay $3,500 less tax than a family where one earner makes $80,000 and the other stays home, they argue? Under income splitting, that $80,000 one-earner family would be $3,500 further ahead.

The anti-splitting side worries that the lower tax receipts resulting from general income splitting (cost estimates run between $1.5 billion and $5 billion a year) would mean that dual-income families and singles would end up shouldering a disproportionate share of the tax load. The pro-splitting side points out that the country's books are in a surplus situation so we can afford to bring this in without increasing taxes. The anti-splitters could then ask why the bulk of this tax break should be delivered to one-income families. The pro side might then argue that income splitting merely restores fairness to a tax system that has long "discriminated" against families with stay-at-home moms.

You get the picture. Any move to allow wider income splitting would prompt a very spirited debate.