Running your farm or small business with your spouse provides the opportunity for tax benefits from a partnership and income splitting.
Farms or small businesses run as a husband and wife partnership can see tax savings through income splitting. But the business has to be a true partnership, which means certain guidelines must be followed.
Many couples operate their business as a partnership so they can use income splitting as a means to achieve overall family tax savings. And these savings from income splitting have generally improved over the past decade with changes to federal personal tax rates and brackets.
While most provinces and territories have followed the federal government lead, the three most western provinces have bucked the trend.
British Columbia and Saskatchewan have significantly reduced their top marginal provincial tax rates, reducing provincial income-splitting opportunities.
And Alberta, since going to a flat 10% tax rate, has totally eliminated any income splitting savings from graduated provincial rates.
But even with reductions in some provinces’ maximum provincial tax rates, the combined federal and provincial income splitting savings are still better across Canada today than they were 10 years ago.
Besides lowering the marginal tax rate, income splitting provides other shelters to reduce your family tax bill.
Various non-refundable tax credits, including those for charitable and political contributions, certain tuition and education amounts, and medical expenses, can be put to better use.
You can also get a better bang from capital gains deductions, from loss carry forwards that would otherwise expire or be used to shelter income in a low tax bracket, and from exemptions from provincial income-based premiums or taxes such as the Ontario health premium.
The table compares income-splitting opportunities available to a spousal business partnership in Ontario and Alberta, and demonstrates the impact of the flat 10% provincial rate in Alberta and the graduated tax rates in Ontario.
Spousal Partnership Income Splitting for Taxable Income of $50,000
Taxable Income @ 50% = $25,000
|Estimated income tax liability||Ontario||Alberta|
|Total estimated income liability (A)||3,713||3,744|
|Add: loss of spousal credit (B)||1,764||2,559|
|Adjusted estimated tax liability (C=A+B)||5,477||6,303|
|Tax otherwise paid by individual (D)||11,602||9,750|
|Tax Savings (D-C)||3,447|
|Tax savings unadjusted (D-C)||6,125|
|Less: estimated Ontario health tax||-300|
|Tax savings adjusted||5,825|
- The taxable income consists solely of self-employed income.
- Current tax rates apply to both parties.
- The Ontario resident is subject to the maximum level of the Ontario health premium before and after income splitting.
While our table reflects a 50-50 spousal split in income, there is no legal reason why a partnership cannot issue a larger proportion of the profits or losses from the business to one of the partners.
The allocations need to be reasonable based on each spouse’s respective contributions to the business in the form of both capital and labour/management services. Canada Revenue Agency (CRA) has the authority under the Income Tax Act to reallocate partnership profits and losses between partners based on these respective contributions.
Farm Income Splitting
Since off-farm income is so common today, many farm couples have moved to an uneven allocation of the farm income to access the best personal tax rates for each of them.
Say, for example, the husband does 80% of the work on the farm while the wife has off-farm income that puts her in a higher marginal tax rate than her husband. It definitely makes sense to establish an 80% allocation of the farm income to the husband and only 20% to the wife.
Should this same couple experience a loss in the farm business, an accounting adjustment may be available to give more of the loss to the wife to deduct from her off-farm income. To achieve this reallocation, the partners would agree to give the more active partner, the husband, the extra income, say the first $20,000 of partnership income, while all other income or any losses are split 50-50.
Administratively, CRA will not permit a partnership to reallocate net partnership income using this “quasi-salary” adjustment to create a loss for a partner from a net profit otherwise realized.
Ensure It’s a True Partnership
While spousal partnerships and income splitting have definite tax advantages, it’s wise to ensure you truly have a spousal partnership for your business. You don’t want to risk CRA questions and reassessment of your tax filings or other liabilities that accompany a partnership.
To make it easier to prove to CRA that a spousal partnership does in fact exist, you should consider setting up a formal written partnership agreement that outlines capital, management, and labour to be invested by each spouse.
Husband and wife should have separate personal bank accounts and financial records, and establish the contribution each makes to the farm. Each should file separate personal tax returns.
Some other criteria CRA uses to judge the validity of a spousal partnership are:
- The ability of each partner to contractually bind the other partner and the farm or business
- Use of the words “partner” or “partnership” in written documentation
- Provision for continuing duration of the relationship between the parties
- Use of a partnership name, joint bank account, joint accounting, and so on
- Formal registration (if any) as a partnership
While there can be tax and other advantages to a partnership arrangement, it does mean that each spouse will have legal liability for the actions of the other.
A partnership arrangement certainly is more complex than a sole proprietorship, involving the need for agreements, additional record keeping and preparation of financial statements, and possibly income tax election forms. If you’re thinking of switching your farm business to a spousal partnership, it’s prudent to seek advice from your tax professional or accountant.