Income Splitting with Corporations

 
 
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 A farmer using a farm corporation to operate has several options with respect to removing income from the corporation. A corporation is a separate legal entity and as such, there are specific methods to extract funds from the corporation. This situation is contrary to a sole proprietorship where the farmer has direct access to all earned income.
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Dividends
Dividends are the distribution of a corporation’s profits to its shareholders. Dividends are not deductible by the corporation. In the farmer’s hands, dividends will be grossed up and eligible for a dividend tax credit. The personal tax rates on dividends are less than the rates on most other types of income.

Salary
Where the corporation pays the farmer a salary, the amount paid is deductible by the corporation and taxable to the farmer as employment income. The Canada Revenue Agency’s position with regard to paying active owner/managers is to consider it a reasonable deduction regardless of the size of the salary. However, salaries to all other individuals must be reasonable.

Since small business corporations are eligible for significantly lower tax rates on taxable income below $500,000, a farmer may decide to pay out a bonus in addition to the base salary to ensure the corporation’s income does not exceed the $500,000 level. However, with lower tax rates in recent years it may make sense to leave income over $500,000 to be taxed in the corporation as well.

Salary to Spouse and Children
The Canadian tax system uses progressive tax rates, so the marginal rate of tax increases as taxable income increases. The 2016 marginal rates for Alberta are as follows:
  • 25 per cent on income up to approximately $45,200
  • 30.5 per cent on income from approximately $45,200 up to approximately $90,500
  • 36 per cent on income from approximately $90,500 up to approximately $125,000
  • 38 per cent on income from approximately $125,000 up to approximately $140,000
  • 41 per cent on income from approximately $140,000 up to approximately $150,000
  • 42 per cent on income from approximately $150,000 up to approximately $200,000
  • 47 per cent on income from approximately $200,000 up to approximately $300,000
  • 48 per cent on income over approximately $300,000
As a result of this progressive system, the incentive is there to pay tax on two salaries of $30,000 as opposed to one $60,000 salary. Therefore, taxpayers have the incentive to “split income” between a high-income earner and a lower income spouse or among children.

Where a farmer carries on business through a corporation, consideration should be given to paying a salary to the spouse or children. The salary must be “reasonable” in light of the services they perform in the business. Such services might include bookkeeping, filing, other administrative work and acting as a director of the corporation.

Tips and Traps
The impact of payroll taxes, Canada Pension Plan contributions and employment insurance should be weighed against any potential tax savings expected from implementing this strategy.

Salary/Dividend Mix
When farming through a corporation, a farmer has the option of the combination of a salary and dividend mix when removing funds from the corporation. Careful analysis is required to determine what the appropriate salary/dividend mix should be for each situation.
The following considerations should be reviewed:
  • The cash flow needs of the farmer;
  • The income level of the farmer;
  • The corporation’s income level;
  • The corporation’s status for tax purposes.
Tips and Traps
The farmer will usually want to have enough salary to allow a reasonable RRSP contribution.

Example of salary/dividend mix
Assuming Alberta resident with no non-refundable tax credits (other than basic exemption)
Approx. Personal Tax
$40,000 wage$6,000
$20,000 wage/ $20,000 ineligible dividend$3,700
$40,000 ineligible dividend$1,600
Note that payment of a wage would allow a deductible RRSP contribution for future years and allow access to Canada Pension Plan while a dividend would not. In addition, wages would provide a tax deduction for the company, resulting in lower corporate taxes.
 
 
 
 
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For more information about the content of this document, contact Joel Bokenfohr.
This document is maintained by Nicole Halvorson.
This information published to the web on July 28, 2014.