One way to reduce the tax burden on your business income is to set up an income-splitting plan.

Income splitting is the process of redirecting income within a family group to take advantage of the lower tax brackets, deductions and credits available to each family member. By transferring income-earning assets from high-income to lower-income family members or by paying reasonable, tax-deductible amounts to family members for their services. Generally, the total tax on family income will be lowest when each member earns approximately the same level of income. People are often surprised at the magnitude of tax savings that can be achieved through income-splitting techniques.

There are a number of ways to structure an income-splitting arrangement for an incorporated business, but most involve an estate freeze and the use of a family trust. An estate freeze is a method of capping the value of a corporation, while allowing future growth to accrue to other family members. Most estate-freeze methods involve the exchange of your common or growth shares (securities that fluctuate with the market) for fixed value preferred shares (set price securities subject to less market volatility). Once the current value of the corporation is fixed, you and other family members can subscribe for new common shares at an affordable amount.

To allow for maximum flexibility, making use of a discretionary family trust to hold the new common shares allows you to control the ownership of the shares and allocate dividends received to low-income family—low-income spouse or adult children—to avoid the “kiddie tax.”

There are many structures you can use to split income and reduce your taxes and you should ensure you investigate all of these opportunities. This is a summary of the general steps and advantages, but a number of detailed tax rules must be considered, so professional advice is strongly recommended.

Business Strategies

Despite these roadblocks, there are a number of income-splitting opportunities for business owners that can provide major tax savings. Some of these opportunities include:

  1. Pay your spouse and children a salary

    If your spouse or children work in your business, consider paying them a salary. The salary must be reasonable given the services performed. A good rule of thumb is to pay them what you would have paid a third party for the same services.

  2. Pay a guarantee fee to a family member

    If your spouse or another family member is required to pledge assets to the business or guarantee a business loan, he or she can be paid a reasonable fee by the business. The fee will also help establish deductibility of the loan as a capital loss should it become a bad debt.

  3. Loan funds to your spouse

    Generally speaking, only income from property is subject to the attribution rules. If your spouse has a promising business venture, you can provide interest-free financing without penalty.

    If the venture is risky, an interest-free loan would not qualify for capital loss tax relief should the venture fail.

  4. Utilize the benefits of incorporation

    One powerful technique involves the use of a corporation to carry on business.

    By incorporating the company, family members can own an interest in your business. A tax saving can be achieved if after-tax corporate income is paid to low-income family members as a dividend.

Bruce Ball, CA, is a national tax partner at BDO Canada LLP.

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