Keeping It In The Family
You Can Deduct Salaries Paid To Relatives As Business Expenses, But There Are Rules
ONE OF THE BENEFITS of hiring family members to assist you in your business is the ability to effectively split incomes within a household. More importantly, you can deduct the amount paid to a family member as a business expense. But be careful. You have to meet two criteria -- real work has to be performed and the amount paid must be reasonable. To illustrate, I've summarized several cases from the Tax Court of Canada below. Pay attention to the subtleties in interpretation.
WORK PERFORMED The files at the tax court are littered with examples of aborted attempts by entrepreneurs to hire relatives to do questionable amounts of work. Take, for example, the 2005 tax case of a commissioned insurance adviser who tried to deduct the cost of salaries he paid to his five kids for various office duties, including filing, telemarketing, banking, data entry and attending cultural events to obtain business. The CRA disallowed the adviser's claim. In tax court, the judge also had trouble understanding why so many employees were needed to carry out the tasks and why so many hours were required. But based on testimony that the children did some work for the adviser, the judge allowed 50% of the salaries to be claimed as deductible business expenses.
In another 2005 case, meanwhile, the courts allowed an entrepreneur to deduct $7,000 paid to each of his two sons, aged 11 and 13, for photocopying and stuffing envelopes for five different mailings he did that year. The entrepreneur was able to demonstrate that the time worked was over 600 hours per child and the salaries were determined to be fair.
REASONABLE AMOUNTS In order to deduct salaries of family members as a business expense, entrepreneurs also have to be able to prove that family members were paid the same amount that would have been paid to non-related third parties.
In a 2004 case, an accountant who only took in revenue of $55,000 that year was successful in deducting $34,500 paid to his wife to handle the administration of his business. As the judge wrote, "many professionals and businessmen make less money from their businesses than their secretaries do" and concluded that the arrangement was "a common and reasonable business deal." A more recent case from 2008, however, disallowed over $61,000 in cash payments a business owner made to his former babysitter and his three children, who were "hired" on an hourly basis to assist the owner to provide specific computer-related services. That decision is now under appeal.