How Will The Changes To Income sprinkling Impact You

As soon as the government started talking about tax reforms for corporations who used income sprinkling as a tax saving strategy small business owners across Canada started to worry about the implications these impending changes would have on them.

Before we dive in and give you the full ins and outs of this tax law change, who it impacts, and what it means for small business owners we want to start by saying that majority of our small business clients will not be impacted by these changes. Those impacted the most are high-income earning professionals, such as Doctors and Lawyers, who have been income splitting with a spouse who is not actively working in their business.

What is income sprinkling?

Income sprinkling aka income splitting is a tax strategy commonly used by higher-income business owners or incorporated professionals to help them personally access more funds from their corporation without the high tax bill. To implement this strategy the corporation pays out company dividends to a lower earning family member of the business owner or incorporated professional, in most cases a spouse or child.  The family member receiving the funds is taxed at their tax rate, which is lower than the higher income earners tax rate.

 

The existing law

The original law around income sprinkling/splitting was the Tax on Split Income (TOSI) rule which applied the highest marginal tax rate to income that was split with a family member under the age of 18. Commonly known as the “Kiddie Tax” this law had not been extended to family members 18 or over.

The New Law

You can probably already see the writing on the wall and if you assumed the new law extends the principles of the “Kiddie Tax” to all family members 18 and over who receive dividend payments from the corporation without actually being an active member of the business, you would be correct.

Exclusions

It should be noted that there are some exceptions to the rule:

  • It doesn’t apply to salaries paid to family members.
  • If you are income splitting with your spouse and you are aged 65 years and over you are exempt.
  • If your family member works consistently in the business 20+ hours per week during its operations within the tax year or can show that they have consistently worked within the business over the past 5 years they will be exempt.
  • If you are 25 or over and you hold Excluded Shares in the corporation and the corporation is not a professional corporation or a business that provides services.

What it means for you

For a majority of small business owners, these changes don’t pose a significant impact. So long as your family member is actively working within the business and can provide documentation to prove that fact the high tax bracket won’t be applied.

For a lot of incorporated professionals that have been income splitting with a spouse who does not actively work in the business these changes will have a significant impact on their tax saving strategy.

Incorporation Series: How do I pay myself if I’m incorporated?

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Balling! When your wallet fat from all that cheddar…..

 

You got 99 problems and your incorporated small business ain’t one? Great. Now it is time to pay yourself. Because you can.  Unlike sole proprietors, owners of a corporation no longer have to claim all of the income from the business as personal income.

“How do I pay myself if I’m incorporated”

You can pay yourself in a variety of ways.

1. Salary

You can add yourself to the company payroll and receive a T4.

This is a more expensive option as the company will have to pay all required payroll taxes on your behalf. Owners are exempt from EI but must pay CPP like other employees.

However, choosing this option will allow you to accumulate more room in your RRSP’s which you can utilize to save on personal taxes once you are making the big bucks.

Additionally if you are the lower income earner and need to deduct child care expenses from your taxable income you will need to be pay yourself with a salary.

2. Dividends

You can declare the money you have taken from the company as a dividend.

To do this you will need to get your bookkeeper or accountant to figure out how much money you took from the business throughout the financial  year and issue you with a T5 from the corporation.

Your personal tax rate will be lower than if you take a salary.

Important Note

As tempting as it may be to pay  yourself as a contractor WE DO NOT RECOMMEND THIS OPTION.

Anytime the CRA feels they are missing out on receiving taxes they feel they are entitled to ( which in this case would be payroll taxes)  they will, put quite simply, come after you!

For more information about the penalties for incorrect employee classification check out our blog post Employee VS Contractor – CRA Penalties for incorrect worker classification

In the end we recommend that you talk to your bookkeeper or accountant before you decide how you are going to pay yourself so that you can choose an option that is the most tax effective based on your income requirements.

If you are considering becoming incorporated and would like to discuss your options face-to-face with Teya our business consultant and tax expert you can make an appointment by calling us directly on  604-739-9536  or by requesting an appointment through our contact us page.