Split your income

Income splitting is the process of shifting or "moving" income from the hands of one family member, who pays tax at a high marginal tax rate, to another, who pays tax at a lower marginal rate. The gross income of the household remains the same, but the family's after-tax cash is greater because the tax bill has been decreased. For example, a sole proprietor could hire his or her spouse to work in the business. The spouse would earn a salary, which would be taxed personally in that spouse's hands. The spouse making the salary payment would receive a tax deduction. The spouse receiving the salary would pay tax on the amount. To reduce the family's total tax, the spouse receiving the salary needs to be at a lower tax rate than the spouse that is making the payment.

Consider Ricky and Lucy's situation. Ricky is a musician in Vancouver. He earned $70,000 in 2001. Lucy does not work outside their home because she is busy raising their son, Little Ricky. Lucy earns no income. On $70,000 of income, Ricky would pay approximately $17,300 of combined federal/British Columbia income tax. (This tax is after application of the tax credits for the basic personal amount and the full spousal amount.) Lucy would, of course, pay no tax. Now let's change the facts. Say Ricky hired Lucy on a part-time basis to maintain his books and look after all the administration of his business. For 2001 Ricky paid Lucy $10,000. Ricky's income would drop to $60,000 because he could deduct the $10,000 paid to Lucy in calculating his business income subject to tax. On $60,000, Ricky would pay tax of about $15,000. Ricky would not be able to claim a tax credit for the spousal amount because Lucy's income would exceed $6,922.

On her income of $10,000, Lucy would pay tax of only about $560. (Her tax is quite low because the first $7,412 of her $10,000 in income is not taxed due to her basic personal amount tax credit.) The total personal income tax of Ricky and Lucy would be $15,560 — down $1,740 from the $17,300 in tax Ricky would pay if he reported the entire $70,000 on his own personal tax return. The after-tax funds available to the family have increased $1,740!

Where a family member is paid a fee or salary for services provided to your business, the amount paid must be "reasonable" in the Canada Customs and Revenue Agency's view. In determining what is reasonable, the CCRA looks at the services rendered, the skill set needed, the time commitment, and what a non-family member would be paid in the circumstances.

In addition to paying a spouse to help you in your business, and to take advantage of the tax savings of income splitting, you can also have your kids help out. Remember, each child can receive $7,412 of income in 2001 and pay no tax because of the basic personal amount tax credit. Another advantage of income splitting is to provide other family members with "earned income" to permit them to have some RRSP contribution room for the next year.

Where the business is operated through a corporation, income splitting with your spouse can be done through the payment of dividends, provided the spouse is a shareholder of the corporation. Since your spouse would be receiving dividends as a shareholder, he or she would not have to provide any services to your business. Where an individual's sole income is dividends, he or she can receive a certain amount of dividends and pay absolutely no personal tax due to the combination of the basic personal amount credit and the dividend tax credit. The actual dollar amount of dividends you can receive tax-free depends on your province of residence. For example, an individual resident in Manitoba can receive about $13,000 in dividends without paying tax, while a person in Newfoundland can receive $27,230. Keep in mind, however, that paying dividends to minor children won't work. Since the 2000 tax year, minor children will now pay tax at the top marginal rate on dividends received from a private (non-public) corporation. Kids cannot even claim the basic personal credit amount to offset the tax. However, the payment of dividends to adult children still works for income splitting. Remember, though, that if the adult kids are already subject to tax in the top tax bracket, the income shift will not result in any tax savings.

Timing is everything: Asset purchases and asset disposals

When you purchase assets for your business (such as computers, office equipment, and machinery) you can claim capital cost allowance (CCA) or "tax depreciation" each year. The amount of depreciation you claim is expressed as a percentage. Different types of assets have different CCA, or depreciation, rates. In the year an asset is acquired, only half of the regular CCA percentage can be claimed. The "half-year" rule was introduced many years ago as a disincentive for business owners to go out on the last day of the business's taxation yearend and purchase significant capital assets. Before the half-year rule was introduced, some business owners could expect a significant CCA deduction on an asset that they'd only owned for, say, one day in the whole tax year.

A purchase late in your business's tax year is no longer as attractive as it was before the introduction of the half-year rule — but it is still attractive. If you are planning to purchase an asset, do so before the year-end to be able to take the CCA deduction as soon as possible. Conversely, if you are planning to dispose of a capital asset, the actual sale should be deferred until at least a day after the business's taxation year-end. This is because CCA can be claimed on all assets owned by the business on the last day of the taxation year. If you sold the asset prior to the end of the year, no CCA can be claimed.