Income Splitting in Family Businesses 

For small and medium enterprises, income is often taxed at personal rates, which can be quite high. This has led many entrepreneurs to consider incorporating their businesses. Incorporation offers several advantages, including reduced corporate tax rates, the flexibility to choose between salary and dividends, and the potential for income splitting, such as employing family members. 

Several income splitting and tax planning strategies are available: 

• Spousal Registered Retirement Savings Plan (RRSP): This is an effective tax planning tool. If one partner anticipates a significantly higher retirement income than the other, they can contribute to the other’s RRSP. When the lower-earning spouse later withdraws from the RRSP, the income is taxed at their lower rate. 

• Tax-Free Savings Accounts (TFSA): TFSAs are another pivotal tax planning instrument. If a higher-earning spouse has maxed out their TFSA contribution limit, they can transfer funds to the lower-earning spouse’s TFSA. Funds within a TFSA grow tax-free and aren’t taxed upon withdrawal. 

• Attribution Rules: These rules don’t apply to TFSAs. They dictate that income is taxed in the hands of the individual who provided the funds, not the one who owns the investment. For RRSPs, there’s a 3-year rule, meaning funds contributed to a spousal RRSP can’t be withdrawn for at least three years. If withdrawn earlier, the contributing spouse is taxed. 

• Spousal Loan: Here, the higher-earning spouse lends money to the lower-earning spouse at a prescribed interest rate. Proper documentation is essential. The lower-earning spouse can then invest these funds, and any income (above the interest rate) is taxed at their lower rate. Additionally, the interest paid by the lower-earning spouse is tax-deductible. 

• Family Trust: Establishing a family trust can benefit family members with lower incomes. The trust can distribute its investment income to these members. To initiate this, a business corporation lends money to the trust, which then pays interest at a prescribed rate. This interest is tax-deductible for the trust. Business owners can thus shift some of their future income to family members, reducing their tax liability.