Income Splitting - Paying Your Spouse

Income splitting is a great way to reduce your income tax.  This is where business profit it split between you and your partner/spouse to take advantage of the lower personal tax rates for income less than $70k.

For example, if a business makes $100k profit and that is all allocated to one working shareholder, then the income tax owing is $23,920.

If you could justify paying your partner $30k, leaving $70k allocated to you, then the overall income tax owing is $18,290.  That's a cash saving of $5,630 per year.

The more you can justify paying your spouse, the greater your tax saving.  However, there are anti-avoidance tax rules stating that the amount paid to a relative cannot be 'excessive'.

The IRD answered the question of what is 'excessive' in a document released in July 2014.  It is where the amount paid is more than a reasonable reward for the services provided by that relative.

In Case J99 (1987), the profit of a construction company was split $37,109 each to the husband and wife.  The judge agreed that the wife's salary was excessive so her salary was reduced to $28,000.

Following the case above, the IRD gave the following example:

Sue and Peter are equal shareholders in ABC Ltd.  Sue works full time in the business while Peter looks after the children and only does 5 hours a week in the business.  If each was paid $70k, Peter's salary would be significantly out of proportion to the services that he provided to ABC Ltd and would be disallowed.

To reduce the chance that the IRD could adjust an amount of salary allocated to your partner/spouse, I recommend doing the following:

  • Having an employment contract in writing that is signed by all parties;
  • The contract must be binding for at least 3 years
  • The salary is paid with PAYE deducted and monthly PAYE returns filed
  • No part of the salary is paid for inadequate services provided to the company

 

Disclaimer: The above article is general in nature and we recommend you seek professional advice tailored to your specific personal situation.