Factors to consider for income splitting on family farm

There is a tax advantage to splitting farm income among the members of a family.

The more income you have, the higher tax rate you have to pay, so spreading income out among you, your spouse and even your children can have a huge tax benefit.

It is fairly common for small business owners to try to split their income by paying their spouse and children.

However, paying salaries to family members may not be as straightforward as you think. There are rules limiting the amount of income splitting that can be done.

A key rule is that the wage must be reasonable.

But what exactly does reasonable mean? Obviously, there are many opinions.

The following are some good rules of thumb to help determine reasonableness:

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First, the family member you are paying has to actually work for your business. For example, the Canada Revenue Agency would likely reject as unreasonable the case of a prairie farmer paying a salary to his son who lives in Toronto throughout the year.

Secondly, the amount you pay your family member has to make sense. A good measure of this is to look at how much you would pay a non-family member for the same responsibilities.

However, sometimes these situations are not clear. For example, some may argue the added trust and management capabilities that you can expect from a family member are worth a premium above the standard wage.

The courts have helped to define reasonable wages.

Cases in recent years have looked at the reasonability of wages paid to a spouse. The court first looked for the employment contract and the hours of work of the spouse. As you would expect, there was no employment contract and hours of work were not recorded.

This was an issue. However, ultimately the courts looked at the duties the spouse performed to determine reasonability.

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This shows how important it is to look at what tasks the family member is expected to perform to earn the wage or salary paid.

When deciding to pay family members you must also consider the costs of payroll taxes such as Canada Pension Plan contributions and employment insurance premiums.

These costs may outweigh the tax savings that you get from paying your spouse or children.

Another income splitting option is to pay your family member on a contract basis, such as custom work. This often provides a deductable expense, while not paying the extra costs of having a full or part time employee.

However, this strategy can have some repercussions, so be sure to discuss with a tax advisor before using it. Implementing an income splitting strategy can be complicated and involves a lot of professional judgment.

The rules can be complex and each personal situation can be different. It is important to talk with a professional accountant.

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Colin Miller is a chartered accountant and partner with  KPMG’s tax practice in Lethbridge. Contact: colinmiller@kpmg.ca

About the author

Colin Miller — Colin Miller is a chartered accountant and partner with KPMG’s tax practice in Lethbridge. Contact: colinmiller@kpmg.ca.

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