Tax Tips for Paying Family Members in Your Business

Income splitting is an excellent strategy to reduce a family’s tax load and it is even easier when you are self employed. Consider Steve, who currently makes $84,000 in his small unincorporated business in B.C. He wants to pay his new wife, Carin, half this amount, as they work together in the business. Can he do it? How much can he save?

Here’s how the math works out:

• Currently Steve pays $19,815 in income taxes (including $5,089 in CPP contributions). If he pays Carin a salary of $40,000, his net business income will be reduced to $42,193 (because the business will need to pay the employer portion of Carin’s CPP contributions).
• As a result, Steve’s personal tax bill is reduced to $9,301 (including $3,811 in CPP contributions) and Carin’s tax bill will be $5,164 (plus CPP contributions of $1,807). Together they pay $18,079 for income taxes and CPP contributions.
• That’s a savings of $1,736 each year by splitting the income. As a bonus, Carin will now be eligible for a CPP retirement pension when she reaches age 60, and potentially (depending on eligibility) a CPP disability benefit.

This family should also be looking closely at how to maximize earned income for RRSP purposes. This involves producing enough taxable income to reach contribution maximums. There are many benefits from this strategy; for example, the RRSP contribution will reduce net income on the tax return, thereby increasing some tax credits, particularly the newly enhanced Canada Child Benefit.

Another benefit is that future retirement income will be earned on a tax-deferred basis. In addition, it’s possible to tap RRSP funds for the Lifelong Learning Plan or Home Buyer’s Plan. Couples who plan well can even use their tax refunds to fund their Tax Free Savings Accounts (TFSAs)—another way to be sure all their eggs are not in one basket.

However, to legitimately write off the costs of hiring family members, certain rules must be followed:

• work must actually be performed by the family member
• the amount paid must be reasonable for the work, time and effort put into the business by the family member and should be similar to the amount that would be paid a stranger in the same capacity
• the amounts must actually be paid and a normal paper trail, including payroll source deductions and T4 slip issuance, is required.

Check these opportunities out with your Tax Services Specialist.

Evelyn Jacks is President of Knowledge Bureau, Canada’s leading educator in the tax and financial services, and author of 52 books on family tax preparation and planning.

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