Tim and Susan Make it Official

Paying your spouse as a business expense

If you’re self-employed or running your own business and earning considerably more than your spouse, paying them for their help with the business can be an easy way of saving hundreds of dollars on your taxes.

(Jargon Alert!) First, a word about Marginal Tax Rates.

The Marginal Tax Rate is the rate at which a person is taxed for every additional dollar he or she earns. In the Canadian tax system, higher income earners have higher marginal tax rates. Once you reach a certain income level, your marginal tax rate goes up. When someone says they’re in a new tax bracket, what they mean is that their marginal tax rate has changed.

For the tax year 2005, the marginal tax rates for Ontario taxpayers look like this:

[columns-begin]
[one-fourth] Income Level*:

Up to $8,100

More than $8,100 but less than $34,750

More than $34,750 but less than $69,500

More than $69,500 but less than $118,285

More than $118,285 [/one-fourth]
[one-fourth] Marginal Tax Rate
(Federal and Ontario Provincial combined)

0%

22%

31%

37%

40% [/one-fourth]
[one-fourth last=”yes”] [/one-fourth]
[one-fourth last=”yes”] [/one-fourth]
[columns-end]

*Figures are averaged out. The actual income limits may vary by a few dollars.

So if one person is earning $40,000 and his or her spouse is earning $30,000, they’re being taxed at different rates. If the higher-earning spouse happens to be self-employed, he or she can transfer some income to their lower-earning spouse by paying him or her for helping with the business. This simple technique can save hundreds of dollars in taxes.

Please note: We do not ever advocate telling untruths in your tax return. To do so would be a serious tax offence. This technique is only legitimate if:

  • You pay the salary (keep records of this); and
  • The work your spouse does is necessary for earning business or professional income.

Using similar logic, you may also pay a salary to your child, providing the salary is reasonable when you consider the child’s age, and the amount you pay is what you would pay someone else. Don’t forget that in this case, your child would have to file an income tax return.

Example:

Tim is a mechanic running his own shop 50 weeks out of the year, and the business earns him a net income of $45,000. His common-law partner Susan works part-time in an office, earning $23,000. On her days off she spends about 10 hours per week helping out with Tim’s shop, doing paperwork and some accounting. In accordance with tax laws, Susan and Tim file their taxes as a married couple.

Going over the books, Susan suggests that Tim officially pay her for the work she does in the shop, and use that as a business expense to reduce their taxes. Tim wants to know how much this might save them in taxes, if he pays her $20/hour, which works out to $10,000/year (=$20/hour x 10 hours/week x 50 week/year)

Compare:

If Tim doesn’t pay Susan that $10,000, it’s part of his income and he’ll be taxed on it at his marginal tax rate. Because he’s earning more than $33,400 but less than $66,800, Tim’s marginal tax rate is 31% [refer to table above].

Therefore, Tim’s tax on $10,000 is $3,100 (= 31% of $10,000).

However, if Tim pays Susan the $10,000, it’s no longer part of his income, so he doesn’t pay tax on it. Instead, it shows up on Susan’s tax return and she pays the tax.

Because Susan earns more than $8,000 and less than $33,400, she’s taxed at a marginal rate of only 22%.

Susan’s tax on $10,000 is $2,200 (= 22% of $10,000).

So as a couple they can save $900 in tax, just by shifting that $10,000 of income off of Tim’s return and onto Susan’s. Naturally they decide to go ahead with it.

Tim writes Susan a cheque for $10,000, and Susan presents Tim with a receipt for his records. It’s all very official, which gets Tim to thinking about making other things official. He suggests that maybe they could invest that $900 in a ring or something.

Susan shrugs, but says she might consider it if they can find a way to make it deductible.