Income Splitting for Families and Business Owners

Introduction
Understanding income splitting for families and business owners is one of the most powerful — yet highly regulated — tax planning strategies in Canada. Income splitting aims to move income from a high-income family member to one in a lower tax bracket, reducing overall family tax. Historically, business owners used structures like dividends to spouses, adult children, and family trusts. However, CRA introduced Tax on Split Income (TOSI) rules to stop unfair income sprinkling. Today, income splitting is still possible, but only when done correctly under the permitted exemptions. This guide explains how Canadian individuals, corporations, and family businesses can benefit from income splitting safely, legally, and strategically.

Legal and Regulatory Framework
Income splitting for families and business owners is governed by the Income Tax Act, CRA Tax on Split Income (TOSI) rules under section 120.4, dividend taxation rules, RRSP/TFSA regulations, spousal tax rules, Québec’s Taxation Act, and family-trust attribution rules. CRA enforces strict penalties, applying the highest marginal tax rate to income caught under TOSI. Proper structuring and documentation are essential.

What Is Income Splitting?
Income splitting transfers income from a high-income individual to a lower-income family member. Lower-income individuals pay less tax, reducing total family tax. Strategies vary depending on whether income is personal, retirement-related, or generated by a corporation.

Why Income Splitting Matters
Canadian tax brackets increase steeply as income rises. Moving $50,000 of income from a high-income spouse to a low-income spouse can save thousands in taxes. Income splitting:
reduces total tax paid
improves family cash flow
supports retirement planning
optimizes corporate distributions
However, TOSI rules restrict use of dividends for splitting.

Part 1 — Personal Income Splitting Strategies

Spousal RRSP Contributions
A high-income spouse can contribute to a spousal RRSP, generating a tax deduction for themselves while shifting retirement income to the lower-income spouse. This is one of the most powerful and safest income-splitting tools.

Pension Income Splitting
Retirees can split up to 50 percent of eligible pension income with their spouse. RRIF withdrawals after age 65 also qualify. This strategy significantly reduces household tax.

Spousal Loans at Prescribed Rates
A higher-income spouse may loan funds to a lower-income spouse at CRA’s prescribed rate (often very low). The lower-income spouse invests and pays tax at a lower rate. Interest must be paid annually to avoid attribution.

Attribution Rules
Attribution transfers income back to the higher-income spouse when rules are not followed. Proper loan agreements and records are essential.

Canada Child Benefit (CCB) Optimization
Lowering overall family net income increases CCB, benefiting families with young children. Strategic income allocation supports this.

RESP Contributions
Using lower-income spouses for contributions does not split income, but improves family planning and government grant management.

Part 2 — Income Splitting for Business Owners

Income splitting through corporations is more complex because of TOSI rules. TOSI applies the top personal tax rate unless one of several exemptions is met.

TOSI Exemption 1: Excluded Business
Dividends to adult family members are exempt if the individual is actively engaged in the business at least 20 hours per week in the current year or any 5 previous years. Documentation is critical.

TOSI Exemption 2: Excluded Shares
Dividends to adult family members over age 25 may be exempt if:
they own at least 10 percent of votes and value
the corporation earns less than 90 percent of income from services
the corporation is not a professional corporation
This is a powerful exemption for active corporate families.

TOSI Exemption 3: Reasonable Return
Dividends may be exempt if they reflect a “reasonable return” on:
capital contributed
risks assumed
labour provided
property used
This requires strong documentation and financial justification.

TOSI Exemption 4: Age 65+ Exception
If the business owner is 65 or older, income may be split with a spouse regardless of TOSI, similar to pension-splitting rules.

TOSI Exemption 5: Capital Gains on QSBC Shares
Capital gains from selling Qualified Small Business Corporation shares may be exempt from TOSI, allowing income splitting when selling the family business.

Dividends vs Salary in Income Splitting
Salaries to family members must be reasonable based on work performed. Dividends require TOSI analysis. Salaries create RRSP room; dividends do not.

Family Trusts and Income Splitting
Family trusts can support income splitting through capital gains allocation or business succession. However, TOSI and attribution rules still apply. Trusts are powerful when used correctly for estate freezes, corporate reorganizations, and future capital-gains planning.

Part 3 — Income Splitting Through Investments

Joint Investment Accounts
Must follow attribution rules. Capital can be traced to determine who owns investment income.

Corporate Investment Accounts
Passive-income rules affect small-business deduction limits. Income splitting is possible only with proper ownership and TOSI exemptions.

Real Estate Income Splitting
Ownership percentages determine income allocation. Families may add spouses to rental-property ownership for long-term planning, but attribution rules must be reviewed.

Part 4 — Québec-Specific Income Splitting Considerations

Québec enforces stricter administrative controls:
separate TP-1 adjustments
spousal attribution rules under Québec law
verification of hours for excluded business tests
separate QPP/QPIP payroll reporting
Revenu Québec frequently audits professional corporations and family-owned service businesses for improper income splitting.

Common Income Splitting Mistakes
paying salary to a spouse who does no work
issuing dividends without meeting TOSI exemptions
using family trusts incorrectly
loaning funds without interest or documentation
miscalculating spousal RRSP timing
misunderstanding attribution rules
These mistakes often lead to TOSI reassessments and penalties.

Key Court and CRA Positions
Courts routinely uphold CRA’s enforcement of TOSI rules. Cases confirm that:
dividends require proof of meaningful contribution
arrangements must have economic substance
documentation is essential for excluded-business status
CRA reclassification of income will result in top-rate taxation if rules are not met.

Why CRA and Revenu Québec Audit Income Splitting
Income splitting reduces tax revenue, making it a top audit priority. CRA and ARQ target:
family-owned corporations
professional corporations
dividend payments to non-active family members
unreasonable salaries
shareholding arrangements created purely for tax reduction
Businesses must maintain clear records to defend against audits.

Mackisen Strategy
Mackisen CPA designs safe and effective income splitting strategies. We evaluate TOSI exemptions, prepare documentation for excluded-business status, set up spousal loans, optimize RRSP and pension splitting, implement family trusts, structure remuneration plans, and support corporate reorganizations to legally reduce family tax burdens while remaining fully compliant.

Real Client Experience
A Montréal corporation split income among adult children; CRA applied TOSI. Mackisen documented past involvement and reversed the reassessment. A business owner over 65 shifted dividends to a spouse through the age-65 exemption — we structured it safely. A family renting property jointly needed attribution analysis; we restructured ownership for optimal tax outcomes. A professional corporation attempted unsafe dividend splitting; Mackisen corrected the structure and prevented penalties.

Common Questions
Is income splitting legal? Yes — when rules are followed.
What is the biggest risk? TOSI applying the top tax rate.
Can dividends be split with a spouse? Yes under certain exemptions.
Does Québec allow the same rules? Yes, with additional scrutiny.
Are spousal RRSPs still effective? Extremely — one of the best tools.

Why Mackisen
With more than 35 years of combined CPA experience, Mackisen CPA Montreal helps families and business owners implement income splitting for families and business owners legally, safely, and strategically. Our expert planning reduces taxes, protects against CRA and ARQ reassessments, and improves long-term financial outcomes for families and corporations.