Vicki Smith is the co-founder of a stationery store and runs a graphic-design company in Charlottetown, PEI. She pays her husband to do bookkeeping, purchasing and banking for her companies.Nathan Rochford/The Globe and Mail
It's been 30 hours since Vicki Smith, co-founder of Lemon Leaf Prints Inc., an online stationery store, has slept, but the lack of shuteye isn't fazing her.
"I don't even know what sleep is any more," says Ms. Smith, who launched her Charlottetown, PEI, business earlier this year to complement her five-year-old graphic design company, NiteOwl Studio Inc. "It's usually 38 hours before I crash – so I still have a few hours left in me."
Ms. Smith's nocturnal work schedule might be typical of entrepreneurs trying to gain an edge, but she also makes use of a less stressful practice in growing her business: She splits her income with a family member.
With all the media noise about the new federal income-splitting tax policy for families in recent months, it's easy to forget that small business owners and the self-employed have been income splitting for years. The concept is basically the same: The higher income-earner shifts income to the lower earner, who will pay less tax on it.
It's a sound strategy that can take a big bite out of taxes for people who are in wildly different tax brackets. In the Canadian system, the more you make, the more you pay. In fact, someone making $150,000 pays more tax than two people combined making $75,000 each. If you pay your low-income spouse $20,000 from your $90,000 in earnings, not only will you drop to a lower bracket and corresponding lower tax rate, but the $20,000 will be taxed at a lower rate, too. It's a double-win.
Ms. Smith takes advantage of income splitting by paying her husband, Dennis Swan, $20 an hour to do the bookkeeping, purchasing, mailing and banking for her companies on weekends and evenings when he's not at his day job at Holland College. He generally works 15 hours a month on the advice of their accountant, who wants to make sure Mr. Smith avoids being bumped up into the next tax bracket.
"If I'm paying him, it's keeping the money in the family," Ms. Smith says.
Make no mistake, though, rules determine who can participate. For starters, it applies only to immediate family members such as spouses or children. (Sorry, Grandma. Even with your fondness for filing, you don't make the cut.)
"Certainly your other [non-immediate] family members may benefit from the success of your business, but they wouldn't necessarily be part of your tax strategy," explains Sarah Adams, vice-president for small business at the Royal Bank of Canada.
Business owners must truly put the family member to work, and pay for it. It's not good enough to simply say your teenaged son put in 30 hours a month without showing a paper trail that proves the work was legitimate. The Canada Revenue Agency wants to know what tasks he performed and that you're maintaining records of employment. Even if he's making less than $11,000 annually and pays no tax at the end of the year – in 2015, taxpayers can earn up to $11,327 before being required to pay federal tax – you still need to issue a T4 form.
Small business owners, at least those with incorporated businesses, have another option for income splitting that makes sense once they start bringing in the big bucks: paying dividends instead.
A dividend is a portion of a company's earnings. It can only be released to someone who owns shares, though, so in order to use this option, the corporation must be set up so that the family member owns them. The upside is that the CRA's requirement that you pay a "reasonable" salary is taken off the table, says Kevin Stienstra, a certified accountant and senior manager for tax services at Grant Thornton LLP, an accounting and business advisory firm in Beamsville, Ont.
"You can pay someone a dividend of whatever you want, assuming they own shares of the company," Mr. Stienstra says.
But there's a downside. If the spouse owns shares in the company, technically he or she has a say in how it runs, which can get sticky in the event of a separation or divorce. An experienced accountant or lawyer can help find solutions so the owner splits only the income and not control of the company.
Louise Miner, owner of Ottawa Draperies and founder of Rip n Go Inc., an incontinence bed-pad company for kids and adults, hires her husband as an installer on contract. She also pays him a commission, which he can use against expenses.
She maintains that between tax writeoffs and income splitting, her companies save more than $35,000 in taxes each year, which is all the more reason to teach her 13-year-old daughter about company finances now.
"Oh, yes," Ms. Miner says. "As soon as she turns 15, she's on salary."
How much to pay?
Small business owners who employ family members for income-sharing purposes need to pay a reasonable salary, and be able to show the paperwork behind the pay. But what's reasonable?
"If a kid works three days in a year and you try to pay him $30,000, well, that's not reasonable," says Kevin Stienstra, a certified accountant and senior manager for tax services at Grant Thornton LLP in Beamsville, Ont. "The CRA would come along and deny the deduction."
Unfortunately, the CRA doesn't have a hard and fast rule for what's deemed an acceptable salary. But if you pay the family member what you would pay a typical employee, the CRA would have little reason to discount the deduction.
To determine a realistic wage isn't difficult, though. Career websites list average wages for jobs in numerous industries. According to the federal government's Job Bank site, the median hourly wage for an office clerk is $18 an hour, for instance, although the site indicates you could go as high as $28 and still be in the right ballpark.
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