How Does Income Sprinkling Work?

Earlier this summer, the federal government announced plans to change Canada’s tax laws to remove the practice known as ‘income sprinkling’, which lets people lower their income tax burden by distributing money among family members.

With Parliament out on vacation for the season, this issue didn’t boil over until recently. And boil over it did. From the moment the House re-opened its doors, there has been a nonstop flurry of outrage on the issues from both sides of the political aisle, including infighting within Prime Minister Trudeau’s own party.

As an avid CBC radio listener, I’ve been disappointed to hear little in the way of bipartisan discussion on these proposed tax changes. They’ve featured a cavalcade of sympathetic, well-spoken characters explaining why various classes of working people shouldn’t have to pay their full income tax obligation — doctors, dentists, lawyers, farmers.

Unfortunately, what we haven’t heard is the hundreds of professionals who support ending the practice. Nor has there been much talk of what exactly income sprinkling is. While I wouldn’t accuse the CBC of being on board with the CPC, I’d like to see a more in-depth discussion on this issue before consultations end on October 2nd.

In the meantime, I’ll offer my own take.

What is Income Sprinkling?

Before this fall, the vast majority of people would’ve pictured a donut if you asked them about income sprinkling. And to be fair, it is quite the treat if you have the means to grab it.

As is often the case, income sprinkling is not actually a ‘loophole’. It has been recognized and encouraged for years as a legal way for high-earning Canadians to pocket more of their income.

The basic idea is this: someone with a high income creates a corporation and employs their lower-income family members as ‘workers’ in the corporation. The high earner then uses their own income to pay their ‘workers’ a ‘wage.’

The ‘workers’, who may or may not perform any work on behalf of the corporation, pay taxes on their earnings at the lower tax bracket. Then, in one way or another, the high income earner reaps the benefits of that money without having had to pay higher income taxes on it.

Example of Income Sprinkling

Here’s an example of how this might work.

Nice Guy owns a corporation. He’s paying for his adult daughter’s university education. He’s going to use this arrangement to avoid paying income tax.

As the sole owner, Nice Guy could reap the corporation’s $220,000 profit in full. But instead, he employs his adult daughter as a worker in the corporation, paying her an annual salary of $45,000.

His daughter then uses that income to pay for her tuition, rent, and living expenses — which are all things nice guy would’ve been paying for anyhow.

If Nice Guy had taken home the full $220,000 himself, he would’ve landed in the highest tax bracket and handed 33% of that amount to the government. That’s $73,260 in income tax. Instead, his income is $175,000, and he pays at a lower tax rate of 29%, or $57,750.

His daughter, meanwhile, sits in the lowest tax bracket and pays just 15% ($6,750) on the $45,000.

Assuming Nice Guy would’ve had to pay the $45,000 regardless (since he’s paying for his kid’s education, being the Nice Guy he is), he saves $10,760 in income tax by sprinkling some of his income to his daughter.

And he can go further than that. He can also sprinkle some to his wife, who can use that money to buy groceries and pay other living expenses for both of them. He could throw some his son’s way, say $10,000, and have the son re-pay it to him in the form of rent.

Either way, he saves even more on income tax! Great, isn’t it?

Well, for those who have the time and money to incorporate (not to mention the knowledge to take advantage of this scheme), it is nice. But that’s not something most Canadians are capable of doing. Thus the characterization as a loophole for the wealthiest people.

Lawyers and doctors are two of the biggest groups speaking out in defence of income sprinkling, since many are business owners themselves and are accustomed to reaping the benefits of this trick.

The primary argument I’ve heard in favour is that these professionals often spend a lot of their own money to keep their businesses running, and that their non-working family members help them out. Thus, they claim it’s fair to use these people to dodge taxes.

While they’re probably right, the same argument could be made for a lot of Canadians in lower tax brackets as well. We all lean on our families for support; we all spend our own money to buy things for work sometimes.

And the rest of us pay our share of income tax, as we all ought to.

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