If you operate a small business, it's very tempting to income split by paying your spouse and/or kids a salary for services they perform and then deduct those wages as an expense on your tax return. Under the Income Tax Act, in order to deduct such an amount as a legitimate business expense, the expense, including wages, must be incurred for the purpose of earning income and must not be a personal or living expense.
A recent tax case involved a business owner who operated a custom window coverings business and employed her two kids, age 13 and 15, on weekends and holidays. The younger child did some cleaning and answered phones while the older child did mainly clerical work. The children's hours were tracked and their wages were set at between $10 and $12 per hour and, according to a summary schedule, they generally worked "store hours." In 2007 and 2008, the owner deducted $18,000 and $7,000, respectively, for "wages paid" to her two kids.
The Canada Revenue Agency reassessed her, disallowing the business deduction of the kids' wages for the years in question. The issue was not the reasonableness of the wages paid to the two children, which has often been the case when amounts are paid to minor children in other, similar tax cases. Rather, the issue was that the wages were not paid by cash or cheque. Instead, the owner paid for some of the children's "personal expenditures" that, in total, were approximately equal to the wages shown on the summary.
The expenditures were for "luxury items" the children chose to buy using the wages they earned, with their mother retaining the right to veto any of the kids' purchases that were inappropriate.
The CRA argued that the luxury expenditures were not deductible because they were "personal or living expenditures." The judge disagreed and felt that if the children were indeed owed reasonable wages for the work performed, a business expense can be claimed even if these wages were paid by way of purchasing luxury personal items chosen by the children. But because the business owner didn't keep sufficiently detailed records for all the expenditures, the judge made a "rough estimate" and allowed a deduction for 50% of the amounts that she claimed.
The lesson: If you take a similar route to paying your kids, be sure to keep detailed receipts of the purchases made on their behalf.