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(Tuesday, January 19, 2010)Shareholders in Peril – Part III
or “I can write that off in the business, can’t I?”
Summary
There are opportunities for shareholders of private corporations to practice income splitting and to deduct certain expenses on their personal tax returns; however, proper tax planning is necessary to avoid an unpleasant surprise from the tax department. The most common problem areas are wages paid to spouses or children of shareholders, business use of home expenses, and company paid benefits. There are strategies to minimize or eliminate tax reassessments in all three areas.
Article
For the most part, shareholders and their spouses and children are treated, for income tax purposes, the same as any other employee. This means that the amount of taxable benefits, and deductions from employment income, are the same for them as for all employees. Shareholders and their families can often arrange for benefits such as group medical, group insurance, and RRSP matching payments that result in significant tax savings with a little advance planning. However, there is a danger that benefits that are ordinarily not taxable can become taxable if offered solely to the shareholder or his family. This would include merchandise discounts, parking, recreational facilities, social or athletic club fees, computers provided to employees, and group insurance plans. If the terms and conditions for these benefits are the same for all employees, or for all members of a group such as management or a specific office, there will generally not be a problem.
When wages are paid to spouses or children of shareholders, it is important to establish what work was done in return for the wages and that the wages paid were reasonable in the circumstances. If contracts are drawn up and signed, time records are kept as for any other employee, amounts are paid by cheque, the wages paid are the same as would be paid to a non-family member, and particularly if it can be established that someone outside the family would have been employed to do the job, there will generally be no concern. Problems arise when the work is obviously beyond the capability of the person being paid, or when the pay is greatly in excess of a reasonable amount. For example, paying a 10 year old child as a truck driver would not be reasonable, nor would paying a teenaged child for 60 hours of work a week during school time, or paying a spouse $200 per hour for performing a job that any other employee would only be paid minimum wage for performing.
If a spouse or child is performing valuable management services for the corporation, he or she can legitimately be paid either wages or management fees. If the spouse or child then wishes to declare the income as business income, and deduct business expenses against the income, this can be a viable option. There is, however, a danger that CRA may decide that the income is wages, not business income, and deny the deduction of any expenses. This is much more likely to happen if the only services provided are to the shareholder’s corporation. The determination of whether amounts paid are wages or business income can be complex, and should be documented in advance to avoid taxes and penalties due to a CRA reassessment.
If a shareholder is also an employee or officer of the corporation, he or she can deduct the same employment expenses as any other employee. Deductible employment expenses are actually quite limited, consisting mainly of office in home expenses and automobile expenses. In both cases, a signed form has to be provided by the employer certifying that the employee was required to incur these expenses. If, however, the shareholder charges the company for use of the home, and includes the amount charged in rental income, the shareholder can then deduct expenses associated with the rental revenue. The advantage is that the types of rental expenses that can be deducted are much broader than deductible business use of home expenses.
You should talk to your accountant before paying your spouse or children, in order to avoid future problems and to ensure that you derive the maximum tax benefits possible.
