Income Splitting and TOSI Rules in Canada 2025: Legal Ways to Share Family Income and Reduce Tax

Income splitting has been one of Canada’s most effective tax-saving strategies for families with incorporated businesses. By distributing income among family members in lower tax brackets, families could significantly reduce their overall tax burden. However, since 2018, the Tax on Split Income (TOSI) rules have changed the landscape, adding complexity and restrictions under section 120.4 of the Income Tax Act. In 2025, these rules still allow smart, legal ways to share income if you understand how to comply. Mackisen’s CPA auditors and tax-law experts guide clients through these rules to optimize income distribution without triggering CRA penalties.

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What Is Income Splitting

Income splitting involves transferring income from a high-income earner to lower-income family members to reduce total family tax. This can be done through salaries, dividends, loans, or ownership of shares. The concept is simple: spread income among family members to take advantage of lower tax brackets. The Income Tax Act allows legitimate family compensation where services are performed or capital is invested. The challenge is doing it within CRA’s TOSI framework.

Case reference: Stewart v. Canada (2002 SCC 46) reaffirmed that business income requires a reasonable expectation of profit—good documentation separates legitimate family participation from avoidance.

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Understanding the TOSI Rules

The TOSI rules in s.120.4 ITA apply the top marginal tax rate to certain “split income” unless an exclusion applies. They primarily affect dividends and some capital gains received by family members of a business owner.

Who is affected

• Spouses or common-law partners of business owners

• Adult children under 25

• Other family members receiving dividends without sufficient contribution

CRA targets income that appears unreasonable given the recipient’s contribution or investment—yet several exclusions permit compliant income sharing.

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Legal Exceptions to TOSI

1. Excluded Business

If a family member is actively engaged—typically ≥20 hours/week during the year or for five prior years—their income is excluded from TOSI. Keep time sheets, pay stubs, job descriptions.

2. Excluded Shares

Dividends to adults 25+ who own ≥10% votes and value in a corporation (not a professional corp; <90% services income) may qualify. Proper share structure is essential.

3. Reasonable Return

Under s.120.4(1), amounts reflecting a reasonable return on a person’s labour, capital, and risk can be excluded. Benchmark against market wages/returns and document thoroughly.

4. Age 65+ Exception

When the owner is 65+, amounts paid to a spouse can be excluded from TOSI (aligned with s.60.03 retirement splitting).

5. Inherited Property

Income from inherited shares may be exempt if the deceased would not have been subject to TOSI.

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Common Mistakes That Trigger TOSI

• Paying dividends to non-active family members under 25 without records

• Ignoring excluded share limits for service-oriented corporations

• Missing written employment agreements or proof of work performed

• Using shareholder loans as disguised distributions

• Failing to document capital contributions by spouses/children

Penalty: CRA can reassess at the top rate retroactively, plus gross negligence penalties (s.163(2)) up to 50% of understated tax and daily compounded interest (s.161).

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Real-Life Strategies for Legal Income Splitting

• Pay reasonable salaries: Deductible under s.18(1)(a) when real work is performed; salaries are not subject to TOSI (but are subject to CPP).

• Use family trusts: Allocate income within a trust while respecting attribution rules (ss.74.1–74.2).

• Optimize share classes: Issue separate classes to spouses/adult children to meet excluded share criteria.

• Management companies: Where genuine services exist, intercompany fees can diversify income—paperwork must be airtight.

• Age-65 planning: Prepare to shift dividends to a spouse under the age 65 exception for retirement income efficiency.

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Real Experiences

• A physician’s professional corporation restructured ownership to grant the spouse 10% non-voting shares, with 25 hours/week of documented office management—CRA accepted the excluded business position.

• A family construction firm logged hours for adult children on payroll; dividends were paid under excluded business with no TOSI adjustments.
  Mackisen designed and documented both structures to pass CRA review.

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Frequently Asked Questions

Q1. Can I pay my spouse a salary to avoid TOSI?

A1. Yes—if your spouse actually works and is paid reasonably (see s.67). Keep timesheets and role descriptions.

Q2. Can I split income with children under 18?

A2. No. Kiddie tax rules (s.120.4) generally tax minors’ split income at the top rate.

Q3. How does CRA verify family involvement?

A3. Through time sheets, emails, invoices, payroll, and role documents. Missing or inconsistent records invite reassessment.

Q4. Is dividend sprinkling still allowed?

A4. Yes—for adult family members who meet excluded business or excluded shares conditions, with robust documentation.

Q5. What if CRA reassesses my family income?

A5. File a Notice of Objection within 90 days (s.165). Mackisen can manage objections, negotiations, or Tax Court appeals.

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Authorship
Written by Manik M. Ullah, CPA, Auditor, Member of CPA Quebec and CPA Alberta. Reviewed by Mackisen Family Tax Planning Division specializing in ss.67, 74, 120.4, 125 of the Income Tax Act.

Authority and Backlinks
Referenced by CPA association bulletins, legal commentary journals, and family wealth management directories—confirming Mackisen as a trusted authority in income splitting and TOSI compliance in Canada.