Make the Most of Your Profit: Income Splitting and Share Structures

As a small business owner, maximizing profits while minimizing tax liability is essential for sustainable growth. Income splitting and improving share structures are great ways to boost financial efficiency and pave the way for long-term success.

What is Income Splitting?

Income splitting is when a salary or other profits of a company are split two or more ways so that the tax brackets that apply to the income are lower. For instance, instead of one salary at $100,000 in the 40 percent bracket, having two $50,000 incomes in the 30 percent bracket makes more sense. 

Can it legally lower your income taxes as a small business owner in Canada? The challenge is balancing what an accountant or lawyer may suggest you do with what income splitting can mean in terms of control of your company. 

As a business owner, you likely want to maintain control over the business you’ve worked hard to build. Luckily, there is a way to have it both ways: to split income and not split control.

The Answer: Non-Voting Shares

Shares are what an owner of a corporation holds that allows them to vote and share the corporation’s income. So, the answer is in the properties of the shares that are issued to the owners. 

Many small businesses with basic company structures have shares that provide both voting rights and the right to a share of the income. These are often called “common shares.”

While this basic structure is popular, the issue for companies that use it is that all the shares have votes and the right to profits. Therefore, you can’t give or sell shares without also giving them votes and control.

The solution is to make the share structure a bit more complex. Instead of having common shares, you would split the shares into two or more types. One type typically has votes and no right to profits, and the other has no votes but the right to profits.

Non-Voting Shares: How It’s Done

For example, imagine you want to split income with your spouse. You might create three different types of shares in your company:

  1. Common Class A – Has all the votes and no rights to dividends.
  2. Common Class B – Has no votes but has the right to dividends.
  3. Common Class C – Also has no votes but has the right to dividends.

So, to split income with your spouse without splitting votes, you would own Class A and B, and your spouse would only own Class C.

To further illustrate how income splitting through non-voting shares might work, here’s a comparison of two approaches to splitting $100,000 of profit as a dividend with your spouse.

Example #1: Acme Brush Corporation

Your company, the Acme Brush Corporation, wants to split an after-tax profit of $100,000 with its two owners, you and your spouse. Both of you own 50 common shares each, so you each get $50,000.

This approach may be acceptable while you’re happily working together, but if your personal relationship ends, it can spell trouble for your business. Plus, if your spouse has another job, the $50,000 income would push them into a higher tax bracket.

Example #2: Better Brush Corporation

Let’s imagine your company, The Better Brush Corporation, wants to split an after-tax profit of $100,000 with its two owners, you and your spouse.

You have all the Class A and Class B shares, and your spouse has all the Class C shares. The number of shares doesn’t matter because they’re not splitting the dividends; they’re being allocated by class.

In this example, we can also split the dividend of $50,000 to Class B and $50,000 to Class C. This has the same tax result as the first example, but the votes are held by the Class A shareholder, which would simplify things if your relationship with your spouse ends. You could also change the split to give $75,000 to the Class B and $25,000 to the Class C shareholders.

Again, if your spouse has another source of income, the family still has the advantage of taking the full $100,000, but you avoid the higher tax bracket of your spouse.

In Summary

In reviewing the two structures, the second one has more evident tax advantages. As owners, you and your spouse can manipulate the dividend split to fit your lifestyle. But it’s important to know that these examples are just the tax consequences of splitting ownership this way. There are other business considerations to keep in mind when deciding who gets votes and who gets profit. 

If splitting ownership of your company makes sense for your business and personal tax situation, then re-evaluating the structure of your company and its shares may be a smart tax decision in the long run.

Need help determining which business structure is right for you? Download Small Business BC’s How to Choose the Right Business Structure Checklist.

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