Tax advice to small business: Double down on dividends

Brokers who co-own their businesses with family members should consider paying their children and spouses extra dividends before popping the champagne cork this New Year’s Eve.

The federal government plans to expand the tax on split income (TOSI), which currently applies to business owners’ minor children, effective Jan. 1. Finance Minister Bill Morneau released Wednesday additional details on the TOSI legislation, which could be tabled as early as this week. Also Wednesday, the Senate finance committee suggested the government should reconsider tax changes originally proposed this past July.

A business owner’s ability to pay dividends to spouses and adult children tax-free “are limited to zero” after Dec. 31, Ernst & Young Canada tax expert David Steinberg said Tuesday in an interview.

Suppose a brokerage owner works for the business and his or her spouse and/or children are shareholders and do not work for the business. Depending on how the company is structured, and the province in which the brokerage is based, the spouse and children could receive as much as $50,000 in dividends without paying income tax if they have no other source of income, Steinberg reported.

With the tax changes taking effect in 2018, Canadian adults individuals would have to start paying TOSI on “income from the business of a related individual,” if Canada Revenue Agency thinks that income is “unreasonable under the circumstances.”

So, a broker could be better off paying family members more dividends in 2017 than he or she otherwise would have, said Steinberg, EY Canadian tax leader, private client services, in an interview Tuesday. This is because if the business owner waits until next year, his or her family members could be paying more income tax on those dividends.

“I would go as far as saying double up” on the dividends, Steinberg added.

The income tax changes were first announced July 18 by Finance Minister Bill Morneau in discussion paper. The Liberals say it is not fair if a self-employed person can pay less tax by incorporating than another person making the same amount from salary.

A business owner “can receive very favourable tax treatment” by paying an adult child dividends while that child goes to university, said Francesco Sorbara, Liberal MP for Vaughan-Woodbridge, during the Insurance Brokers of Toronto Region’s breakfast November 14.

If an adult child of a business owner has no source of income other than dividends, that person could earn $40,000 a year in dividends from his or her parent and pay “probably little or no tax at all,” Eddy Burello, a tax expert with MNP LLP, told Canadian Underwriter earlier.

But if TOSI gets expanded, those dividends could be taxed at the highest marginal rate — either a 40% tax or 45%, depending on the nature of the dividend,” Burello said at the time. “So now that child will be paying $16,000 in tax versus what they would have paid – zero.”

Morneau announced Dec. 12 more details on how tax on split income would apply. Under the yet-to-be passed new rules, tax on split income would not apply to adults “who have made a substantial labour contribution” to the business or to owners’ spouses, if they are over 65 years old and contributed “meaningfully” to the business. The new TOSI would also not apply to adults older than 24 who own 10% or more of the business, provided the business earns less than 90% of its income “from the provision of services and is “not a professional corporation.”