So you’ve heard that you can income split with children by having them perform administrative duties and paying them a salary? Yes, it’s true. But there’s a caveat: what you pay them must be reasonable. Indeed, it should also be supported by paperwork (e.g. employment contract, recorded hours, deposits, etc.). And here’s why: if you don’t do things properly and give your minor children an unreasonable, then the CRA could disallow you that deduction – while at the same time RECOGNIZING that amount as income in their tax returns (for which they would need to pay tax!). So it’s a double whammy!
Let’s take a look at an example, shall we? In the case of Frank Charles Hokhold (Appellant) v. Her Majesty the Queen (Respondent), 2012 DTC 1160, the taxpayer was a dentist practicing as a sole proprietor out of his home in B.C. His wife and children helped him operate his practice and received a salary for their work. The CRA believed that the dentist should only have been allowed to deduct ten percent (10%) of what he paid his children from 2004 to 2007. The CRA argued that the children’s earnings were not reliable due to a poor paper trail: hours of work records were too similar, it was too difficult to link cheques to the children’s accounts, and given their school work and extra-curricular activities, they couldn’t possibly have earned as much as they did at $10.00 per hour.
The Court tended to believe the taxpayer’s wife. She testified that the children were expected to participate in their father’s business. They came from a background of hard work, starting at early ages (e.g. nine years old in her case). Her children helped with reception, did filing, babysat the children of patients, entered computer data, filled in insurance forms, prepared dental trays for the next day’s procedures, etc. They had their own bank accounts and were expected to pay for their own recreational or extra-curricular activities using their own money. The fact that the practice was in the family homemade it unavoidable to escape work! She had to rely more and more on their children (because third-party employees were expensive). So, in totality, the doctor heavily relied upon his wife and children for helping him run his practice.
The judge accepted the hours of work that the children worked and any irregularities in respect of cheques that were paid to them. The judge also believed that the children worked as long as their father alleged they did – school and all. In the end, the judge allowed the taxpayer to deduct 75% of the amounts he had claimed. While not an overwhelming victory, it sure beats the 10% that the CRA sought to allow.
The moral of the story is this: if you’re going to use your minor children to help you run your practice, make sure you have an agreement in writing (outlining their roles and responsibilities), record their hours, pay them regularly in their own account, and pay them a reasonable amount for the services they provide (e.g. in light of what you might have had to pay someone who isn’t related to you). This way, you have a paper trail that can withstand a CRA audit.