Don't miss an opportunity to pay your spouse and your children for work done to help the business. It keeps them connected to the farm or business, and it can cut your tax bill.
Paying your spouse and children for work done can be a useful strategy to reduce the family's overall tax burden. Canada Revenue Agency (CRA) has no problems with you paying family members as a tax-saving strategy so long as you meet two key conditions:
- You must be able to show that your family members actually did the work
- The wages must be "reasonable in the circumstances"
In addition to moving business income into the hands of family members in lower tax brackets, you also can deduct the salaries paid to these dependants as an expense of your farm or business. You can deduct the salary whether you paid in cash or in kind, as long as the work was necessary for you to earn income and the payment was reasonable for the type of work done and the ages of any children in question.
It's good business practice to keep a detailed record of amounts paid to each family member and to retain documents that support these records. For example, if you paid your kids by cheque, hang onto the cancelled cheques. If you paid by cash, have the kids sign receipts. When you make in-kind payments, such as giving a child livestock or grain instead of cash, you should record the value of the grain or livestock as wages paid. Your child will need to include the same amount in his/her income for tax purposes.
A recent case in the Tax Court of Canada not only demonstrated the importance of keeping detailed employment records for family members, it also reaffirmed the right to pay salaries in kind.
George Aprile employed his wife and two sons, aged 11 and 13, to perform various services that helped him meet the obligations of his own employment contract, which required him to maintain his own office. He gave his wife a cheque for $10,000 for her work. In lieu of cash payments, he bought his sons snowmobiles, motorcycles and gasoline for those vehicles, valued at $7,000 for each boy.
While CRA had accepted Mr. Aprile's deduction of his wife's $10,000 salary from his employment income, because there was proof of payment, it had denied the deductibility of the $14,000 paid in kind to the children. Mr. Aprile appealed the CRA assessment.
Mr. Aprile had kept good records of the work done by his family members. The sons worked about 700 hours each, performing various office duties, including photocopying, mailing and moving files to storage. During his appeal in Tax Court, CRA did not challenge his testimony about the amount and type of work the boys had done, the reasonableness of their $10 per hour rate of pay, or his claim he bought the vehicles in lieu of cash payments. CRA's case was based solely on the lack of cheques or receipts to prove the two disputed $7,000 payments.
Tax Court Judge Ronald Bell was satisfied with Mr. Aprile's credibility and the case he presented. He allowed him the $14,000 in deductions, saying, "It is clear an amount can be paid in kind as well as in money."
This doesn't mean, though, that Tax Court always looks favourably on appeals involving CRA-disallowed deductions of wages paid to family members.
Another recent case involved a wife who owned a retail business. Her husband ran the business on a daily basis. Their 2 children, aged 12 and 17, helped out after school. In 1999 and 2000, the business wrote cheques to the children totalling $12,000 and $3,500, respectively. These cheques were then deposited back in the accounts of either the business or the parents, often without the children even endorsing them. CRA disallowed a deduction for the salaries paid to the children, which this couple also appealed to Tax Court.
The Court found several problems in this case. It ruled that since the children never had control of the money, they did not in fact receive salaries. In addition, no records were kept to document the children's hours of work, and no regular payments were made to them. The cheques were written only at the end of the year when money was available. It was also difficult to accept the stated salaries as reasonable, since the amounts were more than the management fee paid to the husband.
The Court determined that the children's salaries were neither reasonable nor actually paid. In denying the appeal, the judge said, "One is left with the impression that what was involved was tax planning designed to reduce, as much as possible, the overall tax burden of the family," adding that "...when operations are carried out in the fashion that they were it smacks of a sham." Three similar appeals in which children' payment for work were channelled back to the parents also were dismissed.
When the work is actually done and the pay is reasonable, hiring family members can be a good tax-saving strategy. Paying wages to family members also can instill a sense of worthwhile participation and formalize their roles in the family business. However, it's always best to discuss the best course of action for your unique situation with your tax professional or accountant.