Payroll

Paying Family Members From Your Canadian Business - What You Need to Know

Paul Sharpe, CPA, CA
/
June 13, 2024

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Everything you need to know about paying family members from your Canadian business.

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In this article we’re covering a topic that can bring both warmth and strategic benefits to your business -  hiring family members. Whether you're looking to involve your spouse, your kids, or other relatives, there's a lot to gain – but also a few important rules to follow.

We’ll first look at the advantages and the potential pitfalls of hiring family members. After that we’ll get into keeping CRA happy, followed by details on actually HOW to pay family members from your Canadian corporation.

Benefits of Hiring Family Members

First up, the benefits of hiring family members. These benefits range from financial savings to strengthening the business culture. Let’s explore these in detail.

Income Splitting

Tax Savings: One of the most significant benefits of hiring family members is the potential for income splitting. By employing a family member who falls into a lower income bracket, you can distribute income within the family, which may result in a lower overall tax burden. 

This means that instead of you paying a higher rate on all your income, part of it is taxed at a lower rate when paid as salary to a family member.

Increasing RRSP Contributions

Future Savings: When family members, such as children with summer jobs or spouses working part-time, earn income, they also accumulate RRSP contribution room. This contribution room can be carried forward and used in the future when they might have higher incomes. 

For instance, a spouse who works part-time while raising children can save up this room and make significant contributions to their RRSP later on, benefiting from compound growth over time.

We’ve posted an in-depth video covering everything you need to know about RRSPs. Learn about contribution limits and deadlines, how to save on taxes with RRSPs, spousal RRSPs, and the withdrawal process by clicking on the link below.  

CPP Eligibility

Enhanced Retirement Benefits: Employing family members formally means they contribute to the Canada Pension Plan (CPP). These contributions help build their own retirement benefits. 

Starting CPP contributions early, or continuing them during periods they might not otherwise be employed, ensures family members are better prepared for retirement.

Tax Benefits

Business Deductions: Salaries paid to family members are legitimate business expenses and can be deducted from your business income. This reduces the taxable income of your business, lowering the amount of tax your business owes. 

Additionally, there are some types of tax credits that aren’t available unless a person is earning employment income.  So, depending on the type of income earned from the business, family members might also be able to claim non-refundable tax credits, such as tuition or donation credits.  

Working With Loved Ones

This can be a bit of a mixed bag, but if the working relationship is a good one, then it can be quite rewarding to work with family members.

However, it tends to go both ways. If work relationships are strained, that can also bleed into your personal life.

Potential Pitfalls of Hiring Family Members

And there’s our natural segue into the potential downsides to hiring family members in your business.

While hiring family members can bring many benefits, it's important to be aware of potential pitfalls that could arise. 

Here are some of the key challenges you might face.

Perception of Nepotism

Favoritism Concerns: Hiring family members can sometimes be seen as favoritism, which may affect the morale of other employees. Non-family employees might feel overlooked or undervalued if they perceive that family members receive special treatment or unearned promotions.

Mitigation: To mitigate these concerns, ensure that family members are hired based on their qualifications and that their performance is evaluated fairly, just like any other employee. Maintain transparency in hiring practices and be clear about the roles and expectations from the beginning.

Compliance Issues

Risk of Non-Compliance: The Canada Revenue Agency (CRA) has specific rules regarding the employment of family members to prevent abuse of tax benefits. Non-compliance with these regulations can result in penalties and increased scrutiny of your business.

Arm's Length Principle: It’s crucial to treat family members as if they were unrelated employees (arm's length employees). This means paying them a fair market wage, documenting their employment terms properly, and ensuring they perform genuine work for the business. More on this below.

Family Dynamics

Personal Conflicts: Mixing business and family can lead to personal conflicts that affect both work and home life. Disagreements over business decisions can strain personal relationships, making it challenging to maintain a harmonious working environment. I’ve seen this more than a few times.

Impact on Professional Relationships: Tensions in the workplace can also spill over into your family life, causing stress and dissatisfaction. It’s important to set clear boundaries and maintain open communication to manage these dynamics effectively.

Financial Implications

Inconsistent Performance: Family members might not always meet the performance standards expected in a professional setting, which can impact the overall productivity and success of your business. This could lead to difficult decisions about retaining or letting go of family members.

Financial Strain: If the business faces financial difficulties, the pressure to support family members through employment can add to the strain. It can be a good strategy for spouses to diversify risk by having different employers.

Paying Family Members While Keeping the CRA Happy

Due to the close nature of the relationships, CRA has some specific rules in place when paying family members in your Canadian business.

Here are some key considerations to keep the CRA happy.

Equitable Remuneration

Fair Market Wages: The CRA requires that you pay family members a fair market wage, similar to what you would pay a non-family member for the same role. This means the salary should be reasonable and aligned with industry standards. Paying a family member significantly more or less than an unrelated employee for similar work can raise red flags.

Documentation: Keep thorough records of how you determined the wage for your family member. This might include salary surveys, job postings for similar roles, or consultations with industry experts.

Proper Documentation

Employment Contracts: Have formal employment contracts in place for family members. These contracts should outline the job role, responsibilities, salary, and terms of employment, just as you would for any other employee.

Job Descriptions and Timesheets: Maintain detailed job descriptions and require family members to track their hours using timesheets. This documentation helps demonstrate that they are performing legitimate work for the business.

Performance Evaluations: Regularly evaluate the performance of family members and document these evaluations. This shows that their employment is based on merit and that they are held to the same standards as other employees.

Regular Pay

Consistent Pay Schedule: Ensure family members are paid regularly, just like other employees. Irregular payments can raise suspicion about the legitimacy of the employment relationship. Set up a regular payroll schedule, and issue pay cheques or direct deposits consistently.

Payroll Deductions: Deduct and remit the appropriate taxes, Canada Pension Plan (CPP) contributions, and Employment Insurance (EI) premiums for family members. Provide them with T4 slips at the end of the year, just like you would for any other employee.

Employment Relationship

Arm's Length Principle: Treat family members as arm's length employees, meaning their employment terms should be similar to those of unrelated employees. This includes their job responsibilities, hours of work, and salary.

Legitimate Work: Ensure that family members are performing genuine work that contributes to the business. Tasks should be necessary for business operations, and the work should be consistent with their job descriptions.

It’s really all about ensuring that you’re treating employed family members the same as you would treat other employees.

Pay them market-based wages, ensure they have the same duties and performance reviews and be sure to document everything properly.

How to Pay Family Members from Your Canadian Company

Paying family members in your business requires a bit of planning and adherence to CRA guidelines. 

Here’s a step-by-step guide on how to properly pay family members, ensuring that you keep the CRA happy.

Determine Employment Type

Employee vs. Independent Contractor: The first step is to decide if the family member will be an employee or an independent contractor. Employees are on payroll and receive regular pay cheques, while independent contractors provide invoices for their work.

  • Guidelines: Refer to Avalon Accounting’s blog post on Employee vs. Contractor for detailed guidance on making this distinction. Misclassification can lead to compliance issues and penalties.

Set Fair Wages

Market-Based Salaries: Establish a fair market wage for the role. Use salary surveys, industry standards, and job postings for similar positions to determine a reasonable salary. Ensure the wage is neither significantly higher nor lower than what you would pay an unrelated employee for the same job.

The annual Randstad salary guide is an amazing free resource for determining fair market salaries for the job and your geographical location.

Document Wage Determination: Keep detailed records of how you determined the wage. This documentation is crucial for demonstrating to the CRA that the salary is fair and reasonable.

Payroll Process

Set Up Payroll: Once the employment type and salary are determined, set up your payroll system. 

For detailed guidance on setting up and running payroll in Canada with our favorite software, refer to Avalon Accounting’s payroll guide.

Alternatively, you can watch our video series on how to run payroll in Canada for a simplified manual method of running payroll.

Regular Pay Schedule: Establish a regular pay schedule, whether bi-weekly or monthly. Consistent payment schedules help maintain the legitimacy of the employment relationship.

Payroll Deductions

Withhold Appropriate Taxes: Deduct income tax, Canada Pension Plan (CPP) contributions, and Employment Insurance (EI) premiums from the family member’s salary. This is the same process as for any other employee.

Issue T4 Slips: At the end of the year, provide family members with T4 slips that detail their earnings and the deductions made. This ensures they are properly taxed on their income.

Regular Pay

Consistent Pay Schedule: Ensure family members are paid regularly, just like other employees. Irregular payments can raise suspicion about the legitimacy of the employment relationship. Set up a regular payroll schedule, and issue pay cheques or direct deposits consistently.

By following these steps and leveraging resources like Avalon Accounting’s payroll guide and video series, you can ensure that you are paying family members properly while staying compliant with CRA regulations. 

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Article by
Paul Sharpe, CPA, CA
.
Originally published
June 13, 2024
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