Paying family members through your business

Start with the real question: is there real work?

Paying a spouse, partner or child through your business can be entirely legitimate. The CRA allows a deduction for salary paid to a child or to a spouse or common-law partner, but only when the work is necessary to earn the business’s income and the amount is reasonable. The CRA’s test for a child is that you actually pay the salary, that the work is needed to earn business income, and that the pay is reasonable for the child’s age and no more than you would pay someone else for the same work.

Before you add anyone to the payroll, write down what they will do, how many hours, and what an outsider would be paid for it. Filing, cleaning or social media work for a few hours a week is easy to support; pay far above market, or for work nobody can describe, is not. Settle the role first and the payroll mechanics second.

Set up the pay like any other employee’s

A related employee is still an employee. The CRA’s guidance says you must deduct income tax as you would for other staff, and that salaries paid to children and to a spouse or common-law partner are reported on T4 slips like anyone else’s. Pay them by a traceable method on a regular schedule, ideally from the business account into their own bank account.

Put the arrangement in a short written note: job description, hours, rate, pay dates and start date. If you operate through a corporation, the corporation is the employer and the note should be signed on its behalf. Our guide to hiring your first employee covers payroll set-up steps.

CPP and EI for related employees

CPP and EI do not follow the same rule for family. For CPP, the CRA says that if you and your employee are related you must still deduct contributions as usual, with one exception: a spouse or common-law partner whose pay you cannot deduct as an expense under the Income Tax Act. Confirm that point before setting up the payroll.

EI is different. Related people are generally treated as not dealing with each other at arm’s length, and in that case the employment may not be insurable, which means you would not deduct EI premiums. The employment can still be insurable if, after reviewing all the circumstances, it is reasonable to conclude that you would have hired an unrelated person on a similar contract. The CRA looks at a combination of the pay, the terms and conditions such as hours, how long the work lasts, and the nature and importance of the work, not any single factor.

If the facts are unclear, either you or the worker can ask the CRA for a CPP/EI ruling. On the T4, the CRA lists EI insurable earnings in box 24 when the job is insurable and the exempt (EI) amount in box 28 when it is not.

Records that support the deduction

The CRA’s advice for children is practical: keep documents that support the salary. Keep proof of every payment: the cancelled cheque or bank record for transfers, and a signed receipt in the unusual case that you pay in cash. Beyond payments, keep the written job description, a simple log of hours, the pay rate and how you chose it, and the T4 and remittance records.

A few things are not deductible or are easy to get wrong. The CRA says you cannot claim board and lodging you provide to dependent children or to a spouse or common-law partner as a business expense. A sole proprietor cannot deduct their own salary or drawings, and the same applies to a partner’s.

Dividends to family members and TOSI

Some owners of corporations consider paying dividends to a spouse or adult children who hold shares. The tax on split income (TOSI) is a special tax that applies to certain income received from a related business, including taxable dividends on private corporation shares. Generally you are subject to it if you are a specified individual with split income that is not an excluded amount.

The rules are not a blanket ban. The CRA describes exclusions, and their availability depends on age and involvement. For an adult who is at least 18, income that is not derived from a related business or that comes from an excluded business is an excluded amount, and an excluded business is one in which the person is actively engaged on a regular, continuous and substantial basis. The CRA treats an average of 20 hours a week or more during the part of the year the business operates as meeting that test. For someone at least 25, income from excluded shares or a reasonable return from a related business can also be excluded, and the reasonableness test weighs the work performed, the property contributed, the risks assumed and the amounts already paid.

Excluded shares have conditions of their own, including a minimum ownership percentage and limits on service corporations, so holding shares is not enough. TOSI is calculated on Form T1206 and is claimed on the personal return. Because a family dividend plan can fail on facts rather than paperwork, ask an accountant to test the plan against the current rules before any dividend is declared, and revisit it each year.

Choose between wages and dividends, then review yearly

Wages and dividends solve different problems. Wages require real work, payroll deductions and reporting, and they are deductible to the business when the conditions above are met. Dividends require share ownership and a TOSI analysis, and they are not deductible. Our salary versus dividends guide compares the two for the owner.

Review the arrangement once a year, ideally before year end. Has the family member’s role or hours changed? Is the pay still reasonable? Do the records exist? Has anyone turned 18 or 25, or changed their involvement in the business? Bring the job descriptions, pay records and share register to your accountant, and ask what changes would be sensible before the year closes.