Get to work, kid

There are plenty of personal reasons why hiring your kids or your spouse is a minefield, but there is at least one potential benefit. It’s a tax strategy called income-splitting: you distribute business profits among family members who worked for you along the way and helped generate the returns. By spreading the profits around, you may be able to reduce your tax burden by shifting money from a high-income earner to a person with little or no income.

Before your wheels start spinning, remember that the Canada Customs and Revenue Agency says you can pay yourself and your family members a nice salary as long as it is “reasonable compensation” for the work done. The problem with that, friends, is that “reasonableness,” like beauty, is in the eye of the beholder.

You need a strategy if you want to pay a family member a share of net revenues. Here are three.

1Pay a percentage of profit. If you’re self-employed (not incorporated), you can split the profit (or the bottom line of your profit and loss statement). Use the income statement normally used to prepare your personal income tax return for both you and your partner (for example, your spouse). Include a copy of the statement with both of your T-1s ; the percentage split should show the portion to be included on each of your personal income tax returns.

2Dividends. If you’re incorporated — your company operates as a separate legal entity — consider offering dividends. A Canadian, filing single, without other income or deductions, may earn up to about $25,000 in dividends without paying any personal income tax.

3Wage or salary. You’re putting your kid or spouse on the payroll. As such, there are tax and legal obligations. Be careful how you calculate employment deductions: the family member in question may not be eligible for EI and/or CPP. Also, you don’t have to follow your usual pay cycles (weekly, biweekly, etc.); a lump sum salary paid at the end of the year is an option.

As for how much income to split,

CCRA says your decision must be based on each individual’s performance within the company, your logic must be solid and documented and carry over from year to year, and what they are paid must be reasonable for the work performed.

If you think the amount you’ve chosen to split with a family member seems unreasonable, it probably is. A seven-year-old son who earns $35 an hour “detailing” the truck is going to raise some eyebrows.

Don’t underestimate contributions, either. That mileage log from the company service vehicle is a way to back up your claim for your spouse’s hours spent providing admin services to the company.

To survive a tax audit, you must hold strong convictions about the value and worth of your family members’ participation to the business. Be prepared to back your convictions with documentation. Put some thought into the income splitting between family members at the beginning of a reporting period; don’t try to arrange a haphazard formula after your year-end. Put an agreement in place at the beginning of your fiscal reporting period outlining your decisions behind income splitting.