How to Hire a Family Member Without Breaking Tax Rules

You're building a successful business and need to bring in some expertise. Luckily for you, your family has the right skills: your spouse is great at bookkeeping and your kid has the marketing know-how to get the word out on social. Working with family has potential benefits, too—including reducing your household's overall tax bill. But before you hire a family member, let's look at the pros and cons, plus how to stay on the good side of the Canada Revenue Agency (CRA).

The basics of hiring family members

If your business is in growth mode, hiring family may seem like a logical step—you already know their strengths, and they may already know the business and have an interest in its success. Still, there are several things to keep in mind when employing relatives.

What are the advantages of hiring family members?

• Trust and shared values: Your family members likely share your dream of seeing your business thrive and may go above and beyond to help you get there.
• Cost savings: Hiring a family member offers a number of tax advantages, plus you skip all the steps of external recruiting.
• Succession planning: By getting your family involved now—especially the next generation—they have a chance to learn the inner workings of your business, become invested in its success, and get ready for the transition.

What are the disadvantages of hiring family members?

• Favouritism: If you have other employees who aren't related to you, hiring family members may leave you open to the perception of bias or the idea that you're giving them preferential treatment. Nepotism isn't illegal in Canada, but it could be viewed as discrimination, which raises the risk of a legal challenge or human rights complaint.
• Potential conflicts: When you're the boss and a family member, it can be tough to set boundaries and resolve conflicts.

Income splitting with family members

Hiring family members offers the potential for income splitting. You can hire a family member and deduct their salary as a business expense, which reduces your corporation's taxable income. And because your family member will pay tax on that income at their personal tax rate, which presumably is in a lower tax bracket, it can help reduce your household's overall tax burden. To qualify, the salary your family member collects must be reasonable for the work and properly documented.

Because hiring a family member allows for income splitting, the CRA may keep an eye on wages and the type of work your family member is taking on, to make sure it's reasonable and legitimate. This might increase your chances of being chosen for a tax review or an audit, so you need to keep records to show that:

• The work your family member does is necessary for earning business income.
• The salary is reasonable and an amount you would pay someone else for the same work.
• You actually paid the salary.

Also keep in mind Employment Insurance (EI) limitations. Depending on the type of work your family member does, they may not qualify as EI insurable if the CRA considers them a “non-arm's-length” person—this means that you wouldn't collect EI premiums from their pay. If the terms and conditions of your family member's employment (their rate and frequency of pay, work hours, and tasks) are similar to those of non-related employees, they will be EI insurable.

Who can you hire?

Your business is thriving and you're wondering: Does it make sense to hire family to help out? We have the answers.

Can I hire my wife or husband as an employee in Canada?

Yes. Not only can you hire your spouse or common-law partner as an employee in your business, but doing so may offer some tax advantages.

Can I pay my minor-aged children a salary in Canada?

Yes, you can pay your children a salary to work for your business. But before you do, make sure that:

• Their role is clearly defined (not random tasks) and the work they're doing is of value to your company.
• You're paying them a reasonable rate for their age.
• You keep proper documentation of the hours, pay, and proof of how they're paid.

Can I hire my spouse as an independent contractor in Canada?

You can hire your spouse as an independent contractor, but it's important you treat and pay them as you would a contractor, rather than an employee.

Can I hire other family members: parents, siblings, adult children?

Yes, you can hire other family members to work in your business, with the same considerations around role and reasonable salary as for spouses and children.

How to pay family members properly

Paying your family members regularly and keeping proper documentation of how you pay them is essential. Start by figuring out whether to designate your family member as anemployee or an independent contractor. The CRA has rules that set out each type of worker.

• If your family member will work set hours, collect a regular salary, use your equipment, and work at your office or workplace, they're considered an employee.
• If your family member already has clients of their own and plan to take on a project for you on their own time, using their own equipment (such as a laptop), they're an independent contractor.

Their role will affect how you pay them. For example, an employee will receive a regular salary and you'll withhold taxes and other deductions on their behalf. Independent contractors may be paid per project or at an hourly rate, but you won't withhold taxes or deductions.

You could also pay a family member in different ways, such as corporate dividends, interest, or capital gains, but be aware that federal tax on split income (TOSI) may apply, and you'll end up paying tax at the highest marginal rate.

Payroll deductions, T4s, and documentation

As with any employee, when hiring family, you'll need to collect their Social Insurance Number (SIN) and decide on the frequency of payment (such as weekly or bi-weekly).

With each pay period, you'll deduct income tax at the employee's rate (see the CRA's Payroll Deductions Online Calculator) as well as Canada Pension Plan (CPP) and EI premiums (if eligible). Payroll software and time-tracking solutions can deduct these amounts automatically and keep accurate records.

If you pay your child or spouse by cheque, keep a record. If you pay in cash, ask them to sign a receipt.

At the end of the year, you need to issue all family members who work for you a T4 slip, just as you would for any of your other employees, or a T4A slip if they are contractors. 

Mistakes to avoid when hiring family

Here are a few errors to watch out for when hiring family:

• Missing documentation: The CRA requires you to keep detailed records to verify that your family members' roles and salaries are legitimate.
• Not setting clear roles and expectations: If family members show up on an ad hoc basis or work on random tasks rather than as scheduled employees, it's time to put specific duties and hours in writing.
• Overpaying a family member or paying for no work performed: These actions may trigger a CRA audit or result in a disqualification of tax deductions.
• Paying irregularly or in lump sums: Stick to regular pay periods that apply to all staff.

Simplify your business taxes

For incorporated business owners, keeping track of your income, expenses, and tax payable can be a lot—and your finances may receive extra scrutiny when you're working with family. TurboTax Business can simplify your taxes, with unlimited help from experts.

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