Your Taxes: Married couples in business to get separate taxation

The Israeli tax law does NOT allow married couples to split their income 50/50 and each pay tax separately on their share.

By LEON HARRIS
Jewish wedding in Havana 370 (photo credit: Courtesy JDC)
Jewish wedding in Havana 370
(photo credit: Courtesy JDC)
Many businesses in Israel and elsewhere are run by husbands and wives working harmoniously together.
In most countries, income splitting is allowed.
This means that each spouse pays their own tax on their own share of income from the family business, without regard to income allocated to the other spouse. But not in Israel at present. Israel still has a chauvinistic system of tax.
Let’s take an example. Avraham and Sarah Cohen are married and they run a family travel business in a 50/50 partnership together. In 2013, they make a profit of NIS 1 million.
But the Israeli tax law does NOT allow married couples to split their income 50/50 and each pay tax separately on their share. Nor can the second spouse draw a decent salary from the family firm.
If a couple work together, the maximum that can be allocated to the second spouse is currently NIS 48,960 per year, according to Section 66(e) of the Income Tax Ordinance. And even that paltry amount is subject to conditions.
Each spouse must work at least 36 hours per week for at least 10 months per year in a fixed place of business that is not the family home. If separate taxation is claimed for the spouses for only part of the year, a pro rata calculation applies. The claim for separate taxation must be filed at least a month before the beginning if the first tax year concerned (unless the assessing officer allows a different filing date) and must be renewed every three tax years.
So if Avraham reports income of NIS 951,040 and Sarah reports income of NIS 48,960 (total NIS 1m.), Avraham will pay taxes of around NIS 407,169 and Sarah would pay taxes of around NIS 4,808, resulting in a total income tax and national insurance liability of around NIS 411,977 for the two of them.
By contrast, If they were allowed to each report and pay income tax and national insurance on NIS 0.5m., Avraham would pay taxes of around NIS 193,460 and Sarah would pay taxes of around NIS 192,152, resulting in a total income tax and national insurance liability of around NIS 385,612 for the two of them.
The Israel Tax Authority has over the years zealously imposed joint (aggregated) taxation on spouses who work together. Separate tax calculations are only allowed if the spouses work independently in different activities and firms.
A joint tax return containing these calculations is usually still filed unless the couple are at loggerheads.
This situation has been the subject of many court cases in recent years. But the Supreme Court ruled in the Shikori case that even if the spouses genuinely work together, the law does not allow any more than NIS 48,960 per year to be allocated to the second spouse.
Fortunately, the new Finance Minister, Yair Lapid, has seen the light. On August 7, 2013, he announced that he will work towards repealing the joint taxation of married couples who work together in the same business. The intention is to amend the law by the beginning of 2014.
The minister reportedly said: “The decision is a direct continuation of the policy of placing the worker at the center of industry and to provide an incentive for participating in the labor force, resulting in increased productivity in the economy.
I am glad we have managed to stop the longstanding economic distortion which prevented the growth of family businesses, mainly small and medium sized, which form the central backbone of the Israeli business world.”
The Israel Tax Authority has just published updated guidance to its tax offices dated July 22, 2013, regarding separate tax calculations where issues have arisen. As a draft bill is on the way, the Tax Authority will suspend tax assessment and collection procedures.
But couples don’t celebrate yet. The tax law still has to be amended.
As always, consult experienced tax advisors in each country at an early stage in specific cases.
leon@hcat.co