As a small business owner you juggle with a variety of tasks and responsibilities. Your income is hard earned. If you are the high earner in your family, you want to definitely look into perfectly legal ways of minimizing your tax load.
The three strategies at the heart of tax planning are to take Deductions to reduce the taxable amount, to Defer tax to future years; and to Divide taxable income amongst different tax payers to reduce the total amount of money paid by the family. In this post we will discuss income splitting.
What is income splitting?
High income earners are in a higher tax rate bracket. Families take full advantage of the marginal tax rate variances to reduce the taxable amount at the highest rate. In a nutshell, you are reducing your family’s tax burden by moving income from the hands of one family member who will pay tax at a higher rate, to another who will pay tax at a lower rate.
Income attribution rules limit the ways in which you can transfer certain types of income to a family member with a lower tax rate
You can split your business income by either paying a salary to a family member or by transferring some of your income to your family as dividends. There are certain rules – attribution rules- that you need to follow when splitting income. These rules are different for your spouse, minor children or adult children depending on the type of income. By the way children might be even a grandchild or a nephew/niece. There are legitimate ways in which you can comply with the attribution rules and reduce the tax load to your family.
A minor child includes a child, grandchild, nephew or niece under 18 years of age.
Four savings strategies that work
- Employ and pay a reasonable salary to your spouse or other family member if she/he works in the business. The salary should be commensurate with the tasks performed. Please keep proper records for potential future tax audits.
- Invest in lower earners name, if you invest assets in the name of an adult child as a gift, any income will be tax in your child’s name. If you chose to gift your minor child, then only capital gains can be taxed in his/her name.
- Loan money to the low earner spouse to make an investment. This strategy will work if the spouse pays interest for the loan at the commercial rate. If your spouse doesn’t pay interest at a reasonable rate then the attribution rule will be triggered against you.
- Set a RRSP account. The income earned will grow without tax until funds are withdrawn. Upon withdrawal your adult child will bear the load of the tax in a student lower tax bracket.
There are many income splitting strategies to reduce your tax load in addition to the four listed above.
You can use RRSP space to reduce current taxes, use a spousal plan to split RRSP income, have the higher income spouse pay for household expenses, blend interest into the sale price of an asset, realize losses to offset gains, contribute to a tax free savings account, etc.