Hiring Family Members — Income Splitting & TOSI Rules

Introduction
Hiring family members is a common strategy used by Canadian business owners to reduce taxes, distribute income within the household and support legitimate work performed by spouses and children. When used correctly, income splitting Canada strategies can reduce the overall tax burden and increase after-tax family income. However, hiring family members is also one of the most closely scrutinized areas in Canadian tax law, especially after the introduction of the Tax on Split Income (TOSI) rules. These rules aim to prevent certain types of income splitting that the CRA considers unfair or unreasonable. Québec businesses face additional employment and payroll compliance obligations when involving family members. Because errors in hiring family members can lead to penalties, reassessments and TOSI charges, this guide explains the rules, obligations and tax planning opportunities available to business owners.

Legal and Regulatory Framework
Hiring family members must comply with the Income Tax Act, the TOSI rules introduced in 2018, Québec’s Taxation Act and employment legislation. To qualify as a legitimate business expense, salaries paid to family members must meet the “reasonable compensation” test. This means the payment must be:

• for actual work performed
• for duties comparable to what an unrelated employee would do
• at a wage consistent with market rates for similar tasks

If salaries exceed reasonable amounts or are paid without genuine work, the CRA can deny deductions.

The TOSI rules Canada apply to certain kinds of passive or split income received by family members. These rules target dividends, interest, rental income, capital gains and partnership income paid to related individuals who are not actively engaged in the business. Under TOSI, such income can be taxed at the highest marginal tax rate. Payroll deductions, CPP/QPP and EI rules apply to family members depending on the nature of the job and the business structure. Québec imposes additional requirements for CNESST, QPP, QPIP and provincial payroll taxes. Understanding the regulatory framework is essential when hiring family members.

Key Court Decisions
Courts have ruled repeatedly on issues involving hiring family members and the reasonableness of compensation. In several notable cases, the CRA challenged salaries paid to spouses or children who performed minimal or unverifiable work. Courts upheld the CRA’s position and denied deductions when work was not sufficiently documented. Decisions on income splitting Canada also confirmed that payments made purely for tax savings, without real work or business involvement, are not deductible.

TOSI rules Canada have also been tested in court, with rulings emphasizing active involvement in the business as a key determinant of eligibility for excluded business or excluded shares. Québec courts issued similar decisions involving payroll deductions, T4/RL-1 filings and improper payments to minors. These rulings reinforce the importance of proper documentation, reasonable wages and compliance with hiring family members rules.

Why CRA Targets This Issue
Hiring family members is one of the most heavily reviewed areas in corporate and small business tax. CRA focuses on it because of the high potential for abuse through:
• inflated salaries paid to reduce corporate income
• paying family members who do not actually work
• using dividends to avoid payroll taxes
• claiming business deductions for personal or domestic work
• failing to apply TOSI rules correctly
• shifting income to family members with lower marginal tax rates

CRA auditors routinely request timesheets, job descriptions, payroll records, proof of payment and evidence of actual work performed. Québec authorities also review CNESST, QPP and QPIP eligibility to ensure proper employee classification. Because improper hiring family members strategies reduce overall tax revenue, the CRA closely monitors this area.

Mackisen Strategy
Mackisen CPA provides a structured, compliant and high-impact approach to hiring family members and income splitting Canada strategies. Our process includes:
• determining whether hiring family members is beneficial based on income levels
• preparing proper payroll setup, CRA remittances and RL-1 provincial filings
• establishing clear job descriptions, hours worked and wage justification
• ensuring wages meet the reasonable compensation standard
• evaluating whether dividends to family members qualify under TOSI exclusions
• structuring active involvement to qualify family members as legitimate workers
• optimizing CPP/QPP participation for long-term retirement benefits
• ensuring deductions are fully defensible in case of CRA review

For Québec clients, we also ensure compliance with QPIP, QPP, CNESST, DAS payments and provincial payroll deductions. Our goal is to help businesses use hiring family members strategies safely and effectively.

Real Client Experience
Many business owners come to Mackisen after facing CRA reviews related to hiring family members. One client paid their teenager a full-time wage despite only occasional assistance. CRA denied the deduction and assessed penalties. Mackisen reconstructed reasonable hours, corrected payroll filings and restored compliance.

Another entrepreneur paid their spouse dividends without considering TOSI rules. The spouse had minimal involvement in the business, triggering TOSI taxation at the highest marginal rate. Mackisen restructured the compensation plan to qualify the spouse as an active participant.

A Québec-based contractor hired multiple relatives but failed to remit CNESST and QPP contributions. We corrected all filings and prevented provincial penalties. Another business overpaid a family member compared to market rates, and CRA questioned the deduction. We renegotiated the compensation and documented proper duties to satisfy CRA requirements. These cases demonstrate the importance of professional guidance when hiring family members.

Common Questions
Business owners often ask whether they can hire their spouse. Yes, but wages must be reasonable and documented. They also ask whether they can pay their children. Yes, but minors must perform real work, and hours must be reasonable for their age and role.

Another common question concerns dividends: can family members receive dividends instead of salary? Yes—if TOSI exclusions apply. Active involvement is crucial. Many ask whether paying family members eliminates payroll taxes. It does not; payroll deductions still apply where required. Québec owners also ask whether CNESST applies to family workers. In many cases, it does. These questions help clarify rules around hiring family members.

Why Mackisen
With more than 35 years of combined CPA experience, Mackisen CPA Montreal helps businesses stay compliant while recovering the taxes they’re entitled to. Whether you’re filing your first GST/QST return or optimizing multi-year refunds, our expert team ensures precision, transparency and protection from audit risk. When implementing hiring family members strategies, Mackisen provides full TOSI analysis, payroll setup, documentation support and income-splitting optimization to help business owners reduce taxes safely and effectively.