What Is Income Shifting?

Income shifting reduces tax liability by moving income and assets. Individuals may transfer assets to family members to avoid falling into higher tax brackets or to reduce their tax obligations. Companies can also use this tactic if they have multiple branches, which makes it possible to enact transfers to reduce tax liability for high-earning branches. It is legal to shift income, but taxpayers who take advantage of this potential loophole do need to retain careful documentation and avoid running afoul of limitations.

In a classic example of income shifting, a wealthy person preparing to sell an asset subject to capital gains might not want to do so, because the tax burden would be too high. This person could transfer the asset to a child or another family member who has a much lower income. The person with less income could sell the asset and be taxed at a much lower rate. One reason to do this might be if someone wants to settle a gift on a family member by selling an asset to access liquidity, but would rather not lose a chunk of the transaction to capital gains taxes.

Limitations on asset transfers between family members usually allow to people to transfer a certain amount without penalty. Anything in excess of this amount can be subject to a gift tax. This is designed to prevent income shifting by making it less appealing, while still allowing members of a family to provide financial assistance to each other. It might be necessary to make several such transfers to distribute income and assets within a family, for someone attempting to avoid a high tax burden.

Business can use similar tactics, with branches acting like members of a family who can accept assets. Tax law permits companies to move money freely between branches to make up for funding shortfalls, bankroll projects, and engage in other legitimate business activities. It’s possible to take advantage of this to use income shifting to move income and reduce tax burdens. Companies may exercise caution while doing this to avoid attracting regulatory attention, because they do not want to trigger an audit of their activities.

Before considering income shifting, it can be advisable to discuss the situation with an accountant or tax attorney. These professionals can provide advice based on the latest tax law to ensure that people comply with regulations and maximize their tax savings. It’s important to perform transfers properly, or they may not qualify for protections, and could potentially expose people to even more liability.