Family Trusts for Income Splitting – A Complete Guide by a Montreal CPA Firm Near You

Introduction

A family trust is one of the most powerful tools in Canada for income splitting, wealth transfer, business succession, and long-term tax planning. Properly structured, a family trust allows income and capital gains to be allocated to lower-income family members, significantly reducing the household’s overall tax burden. While the rules around income splitting have tightened in recent years—especially with the introduction of the Tax on Split Income (TOSI)—family trusts remain highly effective when used correctly. This guide explains how family trusts work, how income splitting is achieved legally, and how to comply with CRA’s complex rules.

Legal and Regulatory Framework

Family trusts are inter vivos discretionary trusts established during the settlor’s lifetime. They must file an annual T3 Trust Income Tax and Information Return, maintain proper trust records, follow the trust deed terms, and comply with attribution rules and TOSI legislation. Under the Income Tax Act, trusts can allocate income or capital gains to beneficiaries and issue T3 slips, shifting tax liability to those beneficiaries. CRA requires trusts to keep records of settlors, trustees, beneficiaries, and controlling individuals under new trust reporting rules effective 2023 onward. If misused, CRA may deny allocations or apply TOSI at the highest marginal rate.

Key Court Decisions

In Garron Family Trust v. Canada, the Supreme Court emphasized the importance of determining true management and control of a trust, not merely its legal form. In Somerville v. Canada, CRA denied income splitting through a trust because distributions were not properly documented. In Neuman v. The Queen, the court held that discretionary trust allocations must be genuine and supported by trust documentation. These cases show that family trusts must be properly structured and administered to achieve valid tax benefits.

Why Family Trusts Are Used for Income Splitting

Family trusts allow income—especially business income, investment income, or capital gains—to be allocated to beneficiaries taxed at lower marginal rates. This is especially valuable for: minor children (capital gains only), adult children in school or low-income brackets, retired parents, or spouses taxed at lower rates. Family trusts also: protect assets from creditors, provide centralized control over family wealth, allow business owners to shift future company growth to the next generation, and reduce probate fees and estate taxes.

How Income Splitting Works Through a Family Trust

A family trust can receive: dividends from a family corporation, capital gains from selling shares, rental income, or investment returns. Trustees then allocate income to beneficiaries who are taxed on that income according to their own marginal rates. Capital gains are often used because they are not subject to TOSI for most adult beneficiaries, and only 50% of the gain is taxable. Dividends and income may be subject to TOSI unless the beneficiary meets exemption criteria such as being actively involved in the business (“excluded business”), owning qualifying shares, or being over age 65 with a spouse eligible for income splitting.

TOSI (Tax on Split Income) Rules

TOSI applies to certain income paid to related individuals who did not meaningfully contribute to a business. If TOSI applies, income is taxed at the highest marginal tax rate, eliminating tax benefits. However, TOSI does not apply to: capital gains from the sale of qualified small business corporation (QSBC) shares, income paid to spouses of individuals aged 65+, income paid to adult beneficiaries who work an average of 20 hours per week in the business, and distributions on “excluded shares.” Proper trust structuring allows income splitting while respecting TOSI exclusions.

Common Income Splitting Strategies Using Family Trusts

1. Allocating Capital Gains

Trusts often allocate capital gains—not dividends—to adult children in low-income years, such as during post-secondary education.

2. Freezing Business Value

Owners freeze their company’s value using preferred shares and allow the trust (for the family) to hold common shares capturing future growth.

3. Paying Beneficiaries for Actual Work

If adult children work at least 20 hours per week, business income paid to them may be exempt from TOSI.

4. Spousal Income Splitting at Retirement

Income paid to a spouse after the business owner turns 65 is often exempt from TOSI.

5. Holding Investments for Minors

While income is subject to attribution rules, capital gains can be allocated to minors without attribution, providing legitimate tax savings.

Compliance Requirements

Family trusts must: maintain a written trust deed, keep trustee resolutions, properly document all allocations, issue T3 slips to beneficiaries annually, track tax attributes, comply with new trust reporting rules, and maintain accurate accounting records. CRA audits many trusts with poor documentation, and penalties for non-compliance can be significant.

Mackisen Strategy

At Mackisen CPA Montreal, we help business owners and families establish and manage family trusts that comply fully with CRA rules and maximize income splitting. Our services include designing trust structures, preparing trust deeds with legal partners, managing annual T3 filings, drafting trustee resolutions, ensuring TOSI-safe allocations, planning estate freezes, preparing capital gains strategies, and defending trust allocations in CRA audits.

Real Client Experience

A Montreal business owner used a family trust to split capital gains on the sale of corporate shares—saving the family over $150,000 in taxes. A trust facing CRA review for missing resolutions avoided penalties after we rebuilt all trustee documentation. A family with adult children in university used trust income to pay tuition at lower marginal rates. A business succession plan involving a freeze and family trust passed CRA scrutiny due to proper documentation.

Common Questions

Can minors receive trust income? Yes, but income may be subject to attribution—capital gains are preferred. Can a family trust own company shares? Yes, commonly used for QSBC and estate freezes. Does TOSI eliminate all benefits? No—capital gains, excluded business income, and retirement splitting remain viable. How long does a trust last? Typically up to 21 years before the deemed disposition rule triggers capital gains.

Why Mackisen

With more than 35 years of combined CPA experience, Mackisen CPA Montreal helps families use trusts legally and strategically. Whether your goal is tax reduction, succession planning, asset protection, or generational wealth transfer, we ensure full compliance and optimal results