What is Income Splitting and How Can it Reduce Your Tax Bill?

Income splitting is the transfer of income from a person in a higher tax bracket to a family member in a lower tax bracket.  The more you earn the higher your income tax bracket so “transferring” some of your income to a person whose income is lower than yours will result in having to pay much less tax.

The Family Tax Cut that allowed individuals to split their income with a spouse up to a tax credit of $2000 is no longer available, but businesses can use income splitting strategies still available to them.

There are two ways in which you can split your business income: 

• By paying some of it in salary or wages to a family member 
• Transferring some to family members in the form of dividends

Paying salary or wages to a family member means that you actually hire your spouse or children as employees and pay them from your business income thereby reducing your net income.  For example, if you earn $75,000 and pay your spouse $30,000 this reduces your income to $45,000 which is a lower tax bracket, and your spouse will be taxed even less as $30,000 is even lesser tax bracket, resulting in double tax savings for you both.  As great as this sounds there are strict rules on income splitting which involve hiring members of the family as employees.  

• They must have duties to carry out the same as any other employee.  As with any other employee you must keep employee records to prove that your family member actually worked in the business.
• You have to pay your family member the same wage as you would pay anyone else to do the same job.  You cannot overpay them for the job they do, the rate must be the same as other employees earn in the same industry.

Income splitting by Dividends is another way to pay your spouse or children, but you can only do this if your business is incorporated.  This tax strategy is very flexible in that the value of the dividends and those receiving them can vary from year to year.  Your corporation must be set up so that your spouse and children are shareholders then dividends can be distributed between them.  You can also structure your corporation so that there are non-voting share classes for family members so that they can receive dividends but not vote on decisions made relating to the company. 

For the 2018 tax year, the rules on split income received through dividends is changing.  For more information go to Revenue Canada guidance on split income rules for adults.