Income Splitting in Canada provides a great opportunity to redistribute corporate profits to business owners and their families.
Business owners, particularly, family owned businesses have one superior advantage – those business provide effective means of income splitting with the remainder of the family. Planned properly, a business owner can re-distribute the profits of the business in a very efficient manner.
Canada’s progressive tax rate structure and high marginal tax rates provide incentive for taxpayers to distribute income to members of their family to minimize the overall amount of the family’s tax liability. Income splitting can be achieved by way of salary or dividends to family member. Income splitting will not apply to a family where one member of the family is employed at a corporation. Each employed person will receive his or her salary.
An example of income splitting is where owner operates a company selling widgets. Owner’s spouse is not employed at another organization and assists with the day to day operations of the owner’s company. They have two children, one who is above eighteen and one under eighteen. The Corporation has a gross income of $300,000 and expenses of $100,000. Income splitting can be achieved by way of salary or dividends.
Assuming there are no other sources of income, an individual may be able to receive approximately $35,000 to $37,700 dividends with minimal tax. A family with three income splitters could receive about $105,000 to $113,100 more money at the family table. It should be noted that dividends are paid after tax dollars – the corporation pays its taxable income and then pays dividends to the other family members. However, money earned in the form of dividends will not allow for any RRSP contribution, but on the flip side, there are no CPP/EI contributions to be paid. It should be noted that a prerequisite to receive dividends, the member of the family must be a shareholder of the corporation and above eighteen years of age. A qualified tax practitioner should be consulted to structure the corporation effectively.
Paying a member of the family by way of salary may also achieve income splitting, however, if the amount of the salary paid is deemed unreasonable, the Canada Revenue Agency may then disallow the expense to the corporation, but also include the paid amount as income to the member of the family receiving the income. This is a double-penalty. A dividend is rarely challenged, and may be a better form of achieving income splitting. Furthermore, CPP/EI is also payable for salary paid individuals.
A family trust can also result in tax savings where income, otherwise taxable in the hands of parents or at the trust level, is taxed in the hands of beneficiaries who pay tax at a lower marginal tax rate. However, caution is necessary when family trusts are used to achieve income splitting objectives. The tax on split income and the attribution rules in the Act have broad application. To learn more about family trusts, please read our article under the family trust link.