Income Shifting Defined

What Is Income Shifting?

Income shifting, also known as income splitting, is a tax planning technique that transfers income from high to low tax bracket taxpayers. It is also used to reduce the overall tax burden by moving income from a high to low tax rate jurisdiction.

Key Takeaways

  • Income shifting is also referred to as income splitting.
  • This tax planning technique helps transfer income to lower tax brackets.
  • One common example of income shifting is shifting unearned investment income from a parent to a child.

Breaking Down Income Shifting

Probably the best-known example of income shifting is the shift of unearned investment income from a high tax bracket parent to a low tax bracket child. Often this transfer is by a trust under the Uniform Transfers to Minors Act (UTMA) or in the form of a gift under the Uniform Gifts to Minors Act (UGMA). These parent-to-child income shifts must now conform to the restrictions of the kiddie tax enacted to curb this tax loophole. 

High to Low Tax Bracket Income Shifting 

Upper tax bracket, family business owners may shift income from business earnings distributions to low tax bracket relatives by hiring these relatives to work for the business and paying them salaries. The salaries are deductible as business expenses if reasonable in amount and for work performed.

Loans at no or below-market interest, sale-leasebacks or gift-leasebacks, can also be useful, as can life insurance and annuity policies. These various vehicles are subject to the risk of imputed interest or gift reclassification.

Family business owners can use these income shifting tactics alone or in combination with income splitting to family limited partnerships (FLPs). In this manner, the business owner transfers business assets to FLPs and then sell, gift outright, or in trust, FLP interests to lower tax bracket relatives.

Income Shifting from Tax Inversion

Tax inversion is a conventional technique utilized to shift income from high to low tax jurisdictions. Individuals accomplish tax inversions by transferring income-producing assets to non-grantor trusts formed and residing in low tax states. Businesses may also achieve tax inversions by merging with foreign companies in low tax rate countries and then parking earnings offshore. Examples of inversion to off-shore, low tax countries include Apple, Nike, and Pfizer. 

Multi-national enterprises (MNEs) further reduce taxes by shifting income domestically to their lower tax rate geographical business locations or offshore by making sales at transfer prices or by factoring receivables to their low tax rate foreign affiliates.

Article Sources
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  1. Internal Revenue Service. "Topic No. 553 Tax on a Child's Investment and Other Unearned Income (Kiddie Tax)." Accessed Jan. 24, 2020.

  2. United States Social Security Administration. "SI 01120.205 Uniform Transfers to Minors Act." Accessed Jan. 24, 2020.

  3. Internal Revenue Service. "Deducting Business Expenses." Accessed Jan. 24, 2020.

  4. Internal Revenue Service. "Publication 550: Investment Income and Expenses (Including Capital Gains and Losses)," Page 60. Accessed Jan. 24, 2020.

  5. Internal Revenue Service. "New Data on Family Limited Partnerships Reported on Estate Tax Returns," Pages 1-2. Accessed Jan. 24, 2020.

  6. The Federation of State Public Interest Research Groups. "STUDY: 73% OF FORTUNE 500 COMPANIES USED OFFSHORE TAX HAVENS IN 2016." Accessed Jan. 24, 2020.

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