One of the long-held advantages of working for your own company is that you can pay wages and/or dividends to split income among family members.
Salaries and wages paid to a spouse, partner, or child have always been subject to a “reasonableness” test to justify them as a business expense, and any dividends paid to children under 18 have always been attributed back to the parents.
But for business owners, income splitting has been a reliable strategy to reduce the family’s overall tax bill.
Changes to “tax on split income” or TOSI rules starting with the 2018 tax year are causing confusion about how to comply – and whether income splitting even makes sense. If you have always paid dividends to your spouse, partner, or adult children, you should be aware of how these changes affect you.
The TOSI applies the highest marginal tax rate to any split income when the recipient does not make a sufficient contribution to the family business. This penalty effectively eliminates any tax advantages to income splitting.
An adult family shareholder can be excluded from the TOSI if the income they receive comes from “excluded shares” of a corporation that meets four conditions:
1. Less than 90% of the corporation’s business income is from providing a service;
2. The individual must directly hold shares that represent at least 10% of the votes and value of the corporation;
3. Substantially all (generally this means 90% or more) of the corporation’s income is not derived in any way from a related business; and
4. The business is not a “professional corporation” (e.g., a lawyer, doctor, accountant, etc.) under the federal Income Tax Act.
It’s hard to see how TOSI is even relevant to a family-run trucking business. Under every condition, income derived from shares would not be excluded from the TOSI.
First, virtually every trucking company provides a service. The second condition is targeted at income to individuals holding shares through a trust.
The third condition is meant to prevent breaking up a service business into services and non-services parts using holding companies or sister companies. The fourth doesn’t apply to truckers at all.
Discouraged? You can try another avenue: an “excluded business” exemption. TOSI does not apply to income when an adult family member works an average of 20 hours a week or more for your business.
Canada Revenue Agency has specific rules for hiring relatives, which you should talk to your accountant about, but the pay, terms, and other conditions of the job must be in line with what a non-relative would accept for similar work. The timing of the job – when it occurs and how long it lasts – should correspond reasonably to the length of time such work should take to perform.
If you’re an owner-operator who is away from home for long periods of time, it may take some serious thinking (and off-loading of tasks) to structure a “reasonable” job for a spouse or adult kid that averages 20 hours week, but it can be done.
Records such as timesheets, schedules, logbooks, or payroll records would be sufficient to establish the number of hours the family member worked in a given year.
If your family’s labor contribution does not exempt them from TOSI then perhaps the capital contribution or risk-incurred rules will. Did you wife ever loan money to the business? Is your house supporting the business line of credit?
Running a family business is rewarding but it’s not easy when it comes to taxes. As a new year is about to begin, take time to seek out good advice and plan ahead. Unfortunately, in many cases, income splitting no longer pays dividends.
Scott Taylor is vice-president of TFS Group, a Waterloo, Ont., company that provides accounting, fuel tax reporting, and other business services for truck fleets and owner-operators. For information, visit www.tfsgroup.com or call 800-461-5970.
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