Special to the Financial Independence Hub
In Canada, as many as 80 per cent of small businesses are family enterprises. Whether it’s a start-up or a third-generation company, there’s often plenty of hard work that’s been invested, not to mention financial risk. So it goes without saying that business owners are keen to utilize any tax-saving strategies available to help them maximize take-home profits. Here are five ways family business owners can keep more of their hard-earned dollars.
1.) Pay your family a salary
Don’t miss an opportunity to pay your spouse, common-law partner or children for any work done to help the business. This commonly known income splitting technique allows you to shift some of the income to family members who may be in a lower tax bracket. This can significantly reduce the overall tax bill by moving some of your income out of a higher tax bracket. Examples of work can include filing, answering phones, making deliveries and creative or technical assistance with the business website. Canada Revenue Agency (CRA) allows you to pay family members, as long as you meet two key conditions:
- You must be able to prove that your family members actually did the work
- The wages must be “reasonable under the circumstances”
In addition, this strategy allows family members to increase their CPP contribution, as well as create RRSP contribution room. Both items can benefit the family member in future years; CPP contributions will result in a higher retirement income, and the increased RRSP contribution room can be used in the future to bring down the family member’s taxable income should they be in a higher tax bracket.
2.) Pay a bonus directly to RRSP
There are some tax benefits for the family members as well. As an employee, they can consider contributing a bonus directly into their RRSPs. You’ll avoid tax withholding and the full amount can be used as a deduction, provided the family member has reached the CPP/EI threshold.
3.) Make your spouse and adult children shareholders
Another form of income splitting, for incorporated businesses, is to make family members shareholders and provide income in the form of dividends. By declaring dividends, you’ll spread the business profits among those who have a lower taxable income, thereby reducing the overall amount of tax paid. As shareholders, capital gains can also be split amongst family members should the business be sold. A variation of this strategy includes the use of a Discretionary Trust to allocate income to different adult family members. While it provides similar advantages around capital gains splitting and exemptions, using a trust also provides more control for the owner, which may be a desired option depending on the business’s individual circumstances.
4.) Keep business and personal separate
Other than paying your family for assisting with the family business, it’s recommended to keep personal and business items, such as bank accounts or credit cards, separate. Doing this will help you keep your records organized and avoid costly mix-ups. It can also save you money since your bookkeeper and accountant will spend less time trying to figure out which items are business-related, and reduce the need for any type of proration calculations. Additionally, should you get audited, you’ll save time and stress by not having to dig through mountains of records and receipts.
5.) Don’t miss out on tax credits
Many businesses can take advantage of a variety of tax credits. For example, if the business is in the trades and has apprentices, they may claim the Apprenticeship Training Tax Credit, and employers who hire co-op students from an Ontario college or university can claim the Co-operative Education Tax Credit. Certain tax credits vary by province, so depending on the type of business, it’s worthwhile to understand the different tax credits available both at the federal and provincial levels.
Since there are pros and cons for each of these strategies and each family business is unique, please contact your accountant to determine what options are right for you.
Mahyar K. Hansotia, President of Sobel and Company, Professional Corporation, is a designated Chartered Financial Analyst and Chartered Professional Accountant specialized in providing strategic business advice and tax efficient solutions for owner-managed businesses and high-net-worth individuals. He can be reached at firstname.lastname@example.org