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Small Business Tax Savings in Canada: Income Splitting

Posted by K. Fry on March 14, 2016
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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.

This strategy works if you, as the self-employed individual, are earning more than your family members. Those earning less than you will be in a lower tax bracket, thereby allowing you to save tax.

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:

Family Member

Salary ($)

Tax Rate (%)

Taxable Income ($)

Bruno

70,000

32.98

23,086

Cathy

50,000

31.15

15,575

Carter

15,000

20.05

3,007.50

Jasper

15,000

20.05

3,007.50

   

Total

$44,676

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

 

Another exceptional method for Small Business Owners in Canada to save on their taxes is the Olympia Benefits Health Spending Account. Download The Beginner's Guide to Health Spending Accounts to learn more!

what is a health spending account

 

 

 

Topics: tax tips, hsa, tax savings, small business, canadian small business, income splitting, canadian tax savings, small business tax