If you are a higher income taxpayer and own a business in Canada, you can split your income with a spouse to reduce your net income and taxable income. From reducing the taxpayer’s marginal tax rate to eliminating OAS clawbacks, income splitting can provide numerous benefits. You can transfer some of your income to your family members whose income is lower than yours in order to reduce your tax bill. If both spouses fall in the same tax bracket, income splitting becomes a less attractive tax-saving strategy.
How can you split your business income to save in taxes? You can either pay your family member as wages or salary or you can transfer some of your income to family members through dividends.
Paying wages or salary
One of the most effective ways for a Canadian business owner to reduce their actual income is hiring their children or spouse as employees and giving them some of your income as wages or salary. For example, if your business’s net income is $100,000 and your spouse has been working for your business all year, you can pay him/her a salary, let’s say $40,000. Now, your business net income will drop down to $60,000.
Your spouse’s income will be taxed at a lower rate which will lead to double tax savings. Moreover, this tax-saving strategy will provide some additional benefits. When you pay your spouse some of your income, your spouse can then contribute to CPP and RRSP. This can improve your chances of having a financially stable retirement.
Paying through dividends
Paying your children or spouse through dividends is another way of income splitting. If your business is incorporated, you can take advantage of this flexible tax strategy. The recipient of dividends and amount can vary depending on your yearly income or how much you want to distribute in order to lower your tax bill. Your children and spouse can become shareholders when you set up your corporation.
Your family doesn’t have to be employed by your company in order to receive income in dividends. Although your family members can be both your employees and shareholders, which means they can receive income as salary and dividends. It is advisable to consult an experienced financial planner in order to choose the right tax-saving strategy.
Income splitting requirements
If you choose to split your business income by paying a salary to your family members, your spouse or children have to actually work for the business, which means they will have designated duties to perform and you have to maintain requisite employee record. Make sure to pay your spouse in accordance with their designated roles; you can’t pay him or her $90,000 to perform basic office tasks. Paying your spouse salary and keeping a record of it is the small price you have to pay in order to gain income tax benefits.
“The avoidance of taxes is the only intellectual pursuit that carries any reward.”
— John Maynard Keynes
About Kewcorp Financial
Our job at Kewcorp Financial is to help Canadian business owners minimize their tax bill and improve their overall financial situation. Our financial and tax experts will be happy to guide you as to what tax strategy would be ideal for you depending on your current financial circumstances. Feel free to discuss your tax planning needs with us today!