There are number of ways to split income with family members to provide significant tax savings, but it comes with set of rules. In this article, we explore these rules and share ways to avoid any trouble:
No one wants to pay more taxes than they have to. As your business grow and you earn more money, you’ll face higher tax rates. Income splitting tool can be implemented to lower your taxes such as dividends sprinkling. Lately, there have been changes to these rules to avoid business owners to spilt income with family members to reduce taxes; however, there are exceptions to the these rules that permit income splitting in a variety of situations.
What is income splitting?
Income splitting is the transferring of income from a high-income family member to a lower-income family member to reduce the overall tax paid by the family.
There are four ways to split income
1. Pension splitting
If you have pension income and you are older than 65 years, you can allocate up to 50 percent of you annual pension income to your spouse. Couples can, additionally, choose to split their CPP retirement benefits. Both spouses must, however, be over 60 years old and they must be collecting CPP. Moreover, couples may opt to go for spousal RRSPs: this technique allows a spouse to contribute to the other’s RRSP.
If you are at least 65 years of age, you may want to consider converting a portion of your RRSP to a RRIF (if you do not already have a RRIF) so that you can benefit from pension splitting. Any withdrawals from your RRIF, whether minimum withdrawals or other amounts, would qualify for pension splitting. It’s as simple as completing the Joint Election to Split Pension Income form when filing both of your tax returns.
2. Loan to a spouse
Other tax saving strategy is by lending money to your spouse or partner at the prescribed interest rate rather than making a gift. Small business owners have been using this tool for many years to lower taxes. This strategy works if you want to invest the additional funds to earn investment income. By loaning the money to your spouse and have them invest the money at the ordinary rate, the investment returns, net of the tax-deductible interest on the spousal or partner loan, can then be taxed in the lower-income spouse’s or partner’s hands.
The loan should be supported by a properly drafted loan agreement and interest on the loan must be paid within thirty days of the end of the calendar year.
3. Loan to a family trust
To help fund paying expenses for your children such as fees for private school, sports, music lessons, and other extracurricular activities, you can lend money to a family trust at a prescribed rate. If you simply give money to your kids to invest and don't charge interest on that loan, any income or dividends earned on those funds is attributed back to you and taxed at your marginal tax rate. On the other hand, as long as you charge interest on the loan at the prescribed interest rate, any income above that rate can be taxed in the child's hands. If the child has minimal or no income, the tax payable on any excess return earned above the prescribed rate charged on the loan can be substantially reduced or eliminated. The strategy is to lend the funds to a family trust with your minor children as beneficiaries where payments can be made to them to their benefit.
4. Hire your family members to work for your business
If you own a business, hiring your family member to work for you can be a great way to lower your taxes by income split. For this strategy to work effectively, there are some rules you need to follow, otherwise, the money you pay them might be denied as a valid tax deduction on your tax return. You need to make sure that the amount paid to your family member is reasonable in relation to the work that is performed. You may also want to keep good records, such as copies of timecards, cancelled cheques or electronic fund transfers, to prove to the CRA that a working relationship truly exists and that compensation was paid. The salaries would be deducted by the business, either on your personal income tax return if you are a sole proprietor, or on a corporate tax return if your business is structured as a corporation.
Finally, when you own a business, consider employing family members or asking your tax and legal advisors if it may be beneficial to include family members as shareholders of your corporation. These strategies could result in thousands of dollars of annual tax savings.
At HSPC, our goal is to assist small business and individuals with tax planning strategies to reduce taxes and maximize savings. If you require tax planning services, reach out and we will be happy to help.
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