This is the second part of a four-part series. Previously, tax traps associated with using family members to save taxes were outlined. In this article, we will outline income-splitting opportunities which avoid attribution rules and tax traps.
1. Shifting tax bill
Attribution rules may be avoided if you gift money or property to your children/grandchildren who are 18 years and older. Once you have gifted the money and/or property, any additional growth in investment value will be taxed in the hands of your children/ grandchildren. Moreover, they can also make use of their principal residence exemption in the future to shelter/reduce taxes arising from the sale of real property used as a principal residence.
The higher income spouse can lend money to the lower income spouse at interest rates specified by the Canada Revenue Agency. Interest will be taxed in the higher income spouse’s hands and deducted by the person paying the interest provided that the loan proceeds are used for business or investment purposes. Interest for the current year must be paid no later than January 30 of the following year. Consider this maneuver if the lower income person can achieve a return on the money higher than the interest charged.
2. Changing spending habits
The higher income spouse should pay for all personal expenses including vacations, food, clothing, home, mortgage etc. This enables the lower income spouse to invest their income and be taxed at a lower tax rate on the investment income. Maintaining a proper paper trail to be able to prove the sources and usage of the money is important. Hence, spouses should keep separate bank accounts.
3. Hiring family members
Hire your parents, spouse and children at reasonable amounts for services rendered. As with your non-related employees, job descriptions should be prepared and each family member should also be paid on the same pay cycle, using the same methods as other non-related employees. Payroll deductions should be deducted and remitted along with other amounts withheld from non-related employees. Any salaries paid to your spouse or children will boost their RRSP contribution room, even if they do not currently contribute to their RRSPs. Conversely, salaries paid to family members could affect their entitlement to government assisted income or loans.
Provided certain conditions have been met, the dentist, spouse, parents and children may receive a refund for Employment Insurance (EI) premiums paid over the past three years, and would be exempt from paying EI premiums in the future. Please note that an EI exempt employee cannot claim EI benefits (i.e., maternity or parental leave).
4. Building education funds
You can contribute up to $4,000 per child per year for up to 21 years to a maximum of $42,000 in a Registered Education Savings Plan (RESP). The government also contributes up to 20 per cent of the first $2,000 of an annual RESP contribution to a maximum of $400 for each child. Income earned in the RESP will be taxed only when distributed for educational purposes in the children’s hands (i.e., low tax rates).
5. Incorporating your practice
Consider making your parents, spouse and children shareholders of your Professional Corporation and your in-laws, cousins, etc., shareholders of your technical or hygiene service corporation. This may enable your parents, spouse, each of your children and other relatives to utilize each of their $500,000 capital gains exemption (which translates into a tax savings of as much as $116,000 for each $500,000 capital gains exemption claimed) to shelter taxes arising from the sale of your practice.
Using a trust is also an effective tax reduction technique, which will be covered in Part 3 of this series.