How does income splitting offer tax benefits to business owners?

Income splitting benefits business owners by allowing them to distribute income to family members in lower tax brackets, thereby reducing the household's overall tax burden. This strategy can lead to significant tax savings, freeing up capital for reinvestment into the business or for personal use. It is a strategic approach to maximize financial efficiency.

What legal strategies can business owners employ for income splitting?

Legal income splitting strategies for business owners include paying reasonable salaries to family members for genuine work, issuing dividends to family shareholders, or establishing family trusts. These methods must be structured correctly and comply with tax regulations to prevent penalties.

What key restrictions and considerations apply to income splitting strategies for business owners?

When implementing income splitting, business owners must navigate restrictions like the "tax on split income" (TOSI) rules. These rules are designed to prevent artificial income splitting with family members, especially those not actively involved in the business. Careful planning and professional guidance are crucial to ensure compliance and maximize the strategy's effectiveness.

What specific tax advantages can KWB Accountants & Advisors help Canadian small businesses realize through income splitting?

Income splitting allows Canadian small businesses to significantly reduce their overall family tax burden by distributing income to family members in lower tax brackets. This strategy can lead to substantial tax savings, enabling businesses to retain more capital for growth and investment.

Income Splitting Strategies for Business Owners

Explore income splitting strategies for business owners. Learn how to shift income to family members with lower tax rates to maximize savings.

Do you own a business – either incorporated or unincorporated – and have a spouse or one or more adult children with an income lower than your own?

If so, you may be able to shift your income to these other family members, effectively moving the income from a high tax rate to a low tax rate and decreasing the overall tax burden on your family. This is called income splitting.

Corporations have the ability to pay dividends, which are distributions of after-tax corporate earnings, to adult shareholders regardless of the services they provide to the business. Unincorporated businesses are restricted in this regard as family members can only be paid by way of salary, which must be based on the services they provide to the business. Because of this, corporations have the advantage of being able to split business earnings among family members to lower the overall tax burden on the family. There are special tax rules in place to discourage dividends being paid to children under 18 years of age, though.

An example of this is as follows. For an individual with an unincorporated business earning $100,000 per year and a spouse with no income, the total tax burden on the family would be approximately $22,000. If the business was instead a corporation and dividends were split evenly between the two spouses, the combined corporate tax of the business and the personal tax for you and your spouse would result in a tax burden on the family of only $18,000 – an annual tax savings of $4,000.

To expand on this example, for an individual with an unincorporated business earning $200,000 per year, a spouse with no income, and one adult child with no income, the total tax burden on the family would be approximately $58,000. If the business was instead a corporation and dividends were split evenly between the two spouses and the one adult child, the combined corporate tax of the business and the personal taxes of the three individuals would result in a tax burden on the family of $42,000 – an annual tax savings of $16,000. With the recent increase in top tax rates in Alberta, the savings can be even greater if your income is over $200,000.

If you have an unincorporated business and wish to take advantage of income splitting, there is both legal and accounting work required to incorporate your business. If you fully own a corporation and wish to take advantage of income splitting, there may also be both legal and accounting work required to issue shares to your spouse and adult children. KWB can help you in either situation. Call us today at 780-466-6204 or email info@kwbllp.com to set up an appointment to discuss income splitting and your unique business situation.