Small family-run businesses are generally setup in three ways: a sole proprietorship where all income is reported on one spouses’ return, a partnership where the income is split between spouses or as a corporation with the spouses as shareholders.
Each business type presents its own unique planning considerations when it comes to splitting income and minimizing tax.
Under the sole proprietorship scenario, the most common way to split income is to pay a wage to a spouse that is reasonable for the work actually performed, in the eyes of the CRA. Partnerships generally split income according to a partnership agreement, or by default in spousal situations, usually 50/50. In both these cases, in a personal tax environment that has increasing marginal rates, there can be considerable taxes to pay when “business is good”. This leaves less money available to invest further into the business.
As an unincorporated business owner (whether it be sole proprietorship or as a partnership), the business is on the hook for paying both sides (the employer and employee side) of the Canada Pension Plan (CPP). While of course there is a benefit upon retirement, paying both sides of the premium for the same benefit can be seen as an added “tax” to the business owner.
With the straight-line corporate tax rates (15.5 per cent for small business corporations on the first $500,000 of taxable income), cash-flow can be better managed. As a small business, incorporation offers unique planning opportunities by issuing shares to spouses and if the shares have the right attributes, for a nominal amount some can be issued to adult children. Remuneration in the form of dividends (not subject to CPP and eligible for the dividend tax credit) can be paid to the owners for personal cash needs. The business owner is then taxed personally on cash needed rather than all of business income.
While there are many more considerations to be made when setting up your business structure, those are a few common items of interest. The right business structure has to make sense for your type of business and your unique family situation.
Luc Joye is a partner will Collins Barrow, Elora.
