They’re Clamping Down on Income Splitting: What it means for you

“The only difference between death and taxes is that death doesn’t get worse every time Congress meets.”
– Will Rogers

Income Sprinkling 101:

It’s become common practice for high income Canadians. We get a private Corporation (easily done) and funnel a portion, or all, of our income into it. From there, we pay lower income family members (who may or may not be connected to the business operations) via dividends and it cuts down the tax bill. A lot.

Small businesses are subject to corporate income taxes, which can be considerably less than personal taxes, to the tune of about 35%. The advantage is obvious. But the government doesn’t want people who aren’t legitimately a part of a small business to be paid as if they were.

Say I make $250,000 a year. My spouse doesn’t work and I have a 19 year old in University. I set up a private corporation and bill my services through it rather than doing so personally. My spouse takes $100,000 and my son, who needs to pay rent and tuition, takes $50,000. We save thousands in taxes.

What’s Changing:

On July 18, 2017, Finance Minister Bill Morneau proposed a crackdown. He wants to make it harder for high income Canadians to sprinkle income among family members.

Right now, if you try to flow dividends from your Corporation to your under-18 child, they’ll be taxed at the highest rate. This “kiddie tax” keeps a high income earner from paying their toddler $50,000 via their Corporation.

The new rules would focus on your adult children. It’s been easy to funnel money to them in way of dividends for them to pay for tuition, rent, etc.

Starting soon, family members receiving dividends will be subject to a “reasonability test”, to determine if they’re a legitimate contributor to the small business or collecting money for tax reasons. This test will be stricter for 18-24 year olds, who seem to be the target of the crackdown.

The reasonability test will exist so that legitimate family members in the small business aren’t penalized. If a family member doesn’t pass the test, the “kiddie tax” will be extended to them and they’ll pay the highest tax rate (currently over 41%) on their dividends, effectively wiping out any possible tax advantages.

Passive Income:

The government doesn’t want people to hold excessive wealth to themselves. The economy benefits when we invest and get it circulating.

It’s common for Canadians to invest in stocks, real estate, or other holdings via their private corporation. There’s a significant tax advantage for an owner to invest in his/her company as opposed to in a personal account.

The Feds are cracking down on your corporate investments. They want excess profits to be re-invested actively and not accumulate in your business. While the exact changes are unclear, at this point, it’s apparent that high-income Canadians will likely soon face yet another increase in their overall annual tax bill.