Small Business Tax Savings in Canada: Income Splitting

Incorporating your business and splitting your business income with family members can result in significant tax advantages beyond those available under reduced tax rates for corporations.

If you hire your spouse or children, the corporation can deduct the amount it pays them as an expense, and your family members pay tax at their own personal income tax rates, often substantially lower than your own.

In fact, the first $11,038 of employment income is tax free. If your children are not working, you can save taxes in Canada by paying your children $11,038 each. The salary will be tax deductible to you and tax free for your children.

It’s important that an employment agreement be prepared that specifies the duties that your family member will be performing, and their hourly wage or annual salary. In addition, a weekly log should be kept to support the time spent working by each family member. The reason for doing such things is to ensure there’s a bona-fide relationship between yourself and your family members, that will help refute any challenges by the Canada Revenue Agency.

Here is an example of how income splitting can save taxes for the self-employed in Canada. Bruno and Cathy are married and have two kids, Carter and Jasper. Bruno is a lawyer and runs his own business, which has profits of $150,000 for the year.

Without income splitting:

As the only family member working in his business, Stephan would be taxed at the highest marginal tax rate in Canada of 46.41%. Stephan’s tax owing for the year would be $69,615 approximately (150,000 x 46.41%).

With income splitting (Bruno, Cathy, Carter & Jasper all have jobs in the business):

In order to take advantage of income splitting, Bruno hires his wife Cathy to work as the Office Administrator and gets Carter and Jasper to do important research before cases. Bruno can now pay his wife and kids a salary based on the work they performed. If Bruno was to pay his wife $50,000 and two kids $15,000 each, then Bruno would have left over income of $70,000 for himself. Stephan’s family tax rates would be as follows:

Bottom line: income splitting has allowed Bruno to save $24,939 on taxes this year.