Income Splitting Strategies for Family-Owned Businesses in Ontario

# Income Splitting Strategies for Family-Owned Businesses in Ontario

By Bader A. Chowdry, CPA, CA, LPA | Insight Accounting CPA

Income splitting is one of the most powerful tax planning tools available to family-owned businesses in Ontario and across Canada. When structured properly, it allows business owners to distribute income among family members to reduce the overall tax burden, maximize after-tax wealth, and build long-term financial security.

However, the Canada Revenue Agency (CRA) has implemented strict rulesparticularly the Tax on Split Income (TOSI) provisionsto prevent abusive income sprinkling. Understanding where legitimate income splitting ends and non-compliant tax avoidance begins is critical for Ontario business owners.

This comprehensive guide explores legal income splitting strategies, TOSI compliance requirements, and practical planning techniques for family enterprises in Mississauga, the Greater Toronto Area, and throughout Ontario.

What Is Income Splitting?

Income splitting involves distributing business or investment income among family members who are in lower tax brackets, thereby reducing the family’s total tax liability. Because Canada uses a progressive tax systemwhere higher income is taxed at higher marginal ratesshifting income to lower-earning family members can produce significant tax savings.

Historical Context: Why TOSI Was Introduced

Before 2018, many business owners distributed dividends to adult children, spouses, or other family members who had little or no involvement in the business. This practiceknown as “income sprinkling”allowed families to take advantage of multiple personal tax credits and lower marginal rates without meaningful economic contribution from the recipients.

The federal government introduced the Tax on Split Income (TOSI) rules in 2018 to curtail these practices. Under TOSI, certain types of income paid to family members are taxed at the highest marginal rate (currently 53.53% in Ontario) unless specific exclusions apply.

Understanding the TOSI Rules in Canada

TOSI applies to “specified individuals”typically Canadian residents under age 25 or related to a business owner. Income caught by TOSI includes:

• Dividends from private corporations

• Income from partnerships or trusts where a related person is involved

• Capital gains on the sale of shares or partnership interests (in certain circumstances)

Who Is Affected by TOSI?

TOSI primarily targets:

1. Minors (under 18): Almost all split income is subject to the highest tax rate, with very limited exceptions.
2. Young Adults (18-24): TOSI applies unless the individual meets an exclusion (e.g., active business involvement or owning sufficient equity).
3. Adults (25+): TOSI applies only if the income is from an “excluded business” or if the individual does not meet one of the exclusionary tests.

TOSI Exclusions: When Income Splitting Is Allowed

The TOSI rules include several important exclusions that allow legitimate income splitting for family members who contribute meaningfully to the business:

#### 1. Excluded Business (Substantial Contribution)

Income from a business is excluded from TOSI if the individual:

• Is age 25 or older

• Is actively engaged in the business on a regular, continuous, and substantial basis during the tax year or any five prior years

• Generally works at least 20 hours per week on average during the portion of the year the business operates

This exclusion recognizes genuine family members who are integral to business operations in Mississauga, Toronto, and across Ontario.

#### 2. Excluded Shares

An individual age 25+ can receive dividends free of TOSI if they own at least:

• 10% of votes and value in a corporation

• The shares represent 10% or more of the fair market value of all issued shares

This allows adult children or spouses who have meaningful equity ownership to receive dividends without penalty.

#### 3. Reasonable Return on Contributed Capital

If a family member has contributed capital (cash, property, or borrowed funds) to the business, they can receive a “reasonable return” on that capital. The CRA considers:

• The amount and timing of the contribution

• Risk assumed

• Historical returns for similar investments

• Arm’s-length benchmarks

#### 4. Safe Harbour Capital Return

For individuals age 25+, a prescribed rate of return on contributed capital is deemed reasonable and excluded from TOSI. This provides certainty for conservative income splitting structures.

#### 5. Inherited Property

Property or shares inherited from a parent are generally excluded from TOSI, protecting succession and estate planning outcomes.

Legal Income Splitting Strategies for Ontario Family Businesses

1. Pay Fair Market Salary to Working Family Members

One of the safest and most effective income splitting methods is paying a reasonable salary to family members who actually work in the business.

Why It Works:

• Salaries are not subject to TOSI if they reflect genuine, arm’s-length compensation for services rendered.

• Salary allows family members to:

– Contribute to RRSPs
– Build CPP/QPP entitlements
– Establish an employment record
– Claim employment-related deductions

CRA Compliance:
The salary must be reasonable based on:

• The individual’s role, hours, and responsibilities

• Industry benchmarks and market rates

• Formal employment agreements or documentation

Example:
A construction company in Mississauga employs the owner’s 22-year-old daughter as an administrative coordinator. She works 30 hours per week, manages scheduling, invoicing, and client communications. A fair salary of $45,000$55,000 is reasonable and fully deductible by the corporation, while she pays tax at her lower marginal rate.

2. Use a Family Trust Structure

A discretionary family trust can be an effective vehicle for income splitting, particularly when:

• Multiple beneficiaries (spouse, adult children, parents) are in lower tax brackets

• The business generates significant annual income

• Long-term estate and succession planning are priorities

How It Works:

• The trust owns shares in the operating company (often non-voting, dividend-paying preferred shares)

• The trustee has discretion to allocate income among beneficiaries annually

• Income can be distributed to those in the lowest tax brackets

TOSI Considerations:

• Beneficiaries age 25+ who meet the “excluded business” or “excluded shares” tests can receive distributions free of TOSI

• The trust structure must have genuine business or estate planning purposes (not solely tax avoidance)

Best Suited For:

• Multi-generational family businesses

• Owners planning for succession in the GTA

• High-income businesses with multiple family members involved

3. Pay Dividends to Spouse or Adult Children (with TOSI Compliance)

If family members qualify for a TOSI exclusion, paying dividends can be tax-efficient.

Spouse as Shareholder:

• The spouse must either:

– Work substantially in the business (20+ hours/week)
– Own at least 10% of votes and value
– Receive a “reasonable return” on capital contributed

Adult Children (25+):

• Same TOSI exclusion tests apply

• Particularly effective when children are in university, early career, or lower-income years

Planning Tip:
Consider issuing separate classes of shares (e.g., Class A voting common for the owner, Class B non-voting dividend shares for family members). This allows flexible dividend distribution without diluting control.

4. Prescribed Rate Loans for Investment Income Splitting

A prescribed rate loan allows you to lend money to a lower-income family member at the CRA’s prescribed rate (currently as low as 1% or 2% historically), which they then invest.

How It Works:

• You lend funds to your spouse or adult child at the CRA prescribed rate

• They invest the funds and earn investment income (interest, dividends, capital gains)

• The investment income is taxed in their hands at their lower rate

• They pay you annual interest at the prescribed rate (which you include as income)

Key Compliance Rules:

• The interest must be paid annually by January 30 of the following year (failing to pay on time taints the entire structure)

• Proper loan documentation is essential

• The prescribed rate is locked in for the life of the loan

Best For:

• Families with significant investment capital in Ontario

• Situations where direct business income splitting is not available

• Estate planning alongside income splitting

5. Employ Children in the Business

Employing minor or young adult children can be a legitimate income splitting strategy if:

• The work is real and verifiable

• Compensation is reasonable for the tasks performed

• Proper payroll records, T4s, and remittances are maintained

Tax Benefits:

• Children can earn up to the basic personal amount (~$15,000 federally, ~$11,865 in Ontario for 2026) tax-free

• Salary is deductible by the corporation

• Helps children build work experience, RRSP room, and savings

Example:
A Toronto-area restaurant employs the owner’s 16-year-old son as a dishwasher and prep cook on weekends. He works 12 hours per week at $17/hour. Annual wages of ~$10,600 are fully deductible and taxed at 0% in the child’s hands.

6. Contribute to Spousal RRSP

While not directly business income splitting, contributing to a spousal RRSP allows the higher-income spouse to claim the deduction while income is eventually taxed in the lower-income spouse’s hands upon withdrawal.

Strategic Fit:

• Best for business owners with significant personal income

• Useful when the spouse does not work in the business or qualify for TOSI exclusions

• Long-term retirement and pension income splitting benefits

7. Allocate Investment Portfolio to Lower-Income Spouse

Transfer investments (or funds to purchase investments) to a lower-income spouse so that future income and capital gains are taxed at their lower rate.

Attribution Rules Trap:
Be aware of CRA’s attribution rules:

• If you gift or lend funds to your spouse (without a prescribed rate loan), any income or capital gains are attributed back to you for tax purposes

• Use a prescribed rate loan or ensure the spouse uses their own funds (employment income, gifts from parents, inheritance) to avoid attribution

TOSI Compliance Checklist for Ontario Business Owners

To ensure your income splitting strategies comply with TOSI and CRA scrutiny, follow this checklist:

| Compliance Item | Action Required |
|—————-|—————–|
| Employment Agreements | Prepare written agreements for family members working in the business (role, hours, compensation) |
| Time Tracking | Maintain logs or records demonstrating substantial involvement (20+ hours/week) |
| Dividend Resolutions | Document corporate resolutions declaring dividends to family shareholders |
| Share Ownership Records | Maintain updated shareholder registers and share certificates showing ownership percentages |
| Capital Contributions | Document any capital contributions by family members (cash, property, promissory notes) |
| Reasonableness Analysis | Prepare internal memo justifying salary or dividends as reasonable compared to market benchmarks |
| T4 and T5 Filings | Ensure all payroll and dividend reporting is accurate and filed on time |
| TOSI Designation (Form T1206) | File Form T1206 with family members’ personal tax returns to claim TOSI exclusions |

Common Income Splitting Mistakes to Avoid

1. Paying Dividends Without Business Involvement

Paying dividends to adult children or spouses who have no meaningful role in the business and don’t meet TOSI exclusions will trigger the top marginal rate penalty.

Fix: Ensure family members either work substantially in the business, own sufficient equity, or receive only a reasonable return on capital.

2. Inflating Family Member Salaries

Paying excessive salaries to family members (especially minors or those with minimal responsibilities) invites CRA challenge.

Fix: Benchmark compensation against industry standards and document the rationale.

3. Ignoring Attribution Rules on Spousal Loans

Transferring funds or assets to a spouse without proper structure causes income to be attributed back to you.

Fix: Use prescribed rate loans with proper documentation and annual interest payments.

4. Failing to Document TOSI Exclusions

If you rely on the “excluded business” or “excluded shares” exemption, you must have evidence to support the claim during a CRA audit.

Fix: Keep employment records, meeting minutes, share registers, and capital contribution agreements on file.

5. Misclassifying Dividend Income as Salary

Some business owners attempt to disguise dividends as salary to avoid TOSI or access payroll deductions.

Fix: Maintain proper payroll systems. Salary requires source deductions (CPP, EI, income tax) and T4 reporting.

Real-World Income Splitting Scenarios in the GTA

Scenario 1: Multi-Generational Manufacturing Business in Mississauga

Facts:

• Father owns 100% of a precision manufacturing company generating $800,000 annual net income

• Two adult children (ages 28 and 31) work full-time in operations and sales (40+ hours/week each)

• Spouse manages office administration part-time (15 hours/week)

Strategy:
1. Reorganize share structure: Issue separate class shares to each child (10% each), spouse (5%), father retains 75%
2. Pay reasonable salaries:
– Each child: $90,000 (market rate for their roles)
– Spouse: $40,000 (part-time admin)
3. Distribute dividends: After salaries, declare dividends on remaining income proportionate to ownership

Tax Outcome:

• Children qualify for TOSI exclusion (substantial involvement + 10% ownership)

• Spouse salary is reasonable for services rendered

• Family saves ~$65,000 in tax annually vs. father taking all income personally

Scenario 2: Professional Services Firm in Toronto

Facts:

• Lawyer operates through a professional corporation

• Spouse does not work in the firm

• Net professional income: $450,000 annually

Strategy:
1. Spousal RRSP contributions: Maximize annual contributions ($31,560 for 2026)
2. Prescribed rate loan: Loan $500,000 to spouse at 2% prescribed rate; spouse invests in dividend-paying portfolio
3. Family trust: Establish trust owning non-voting shares; distribute dividends to spouse and adult children when they qualify for TOSI exclusions

Tax Outcome:

• RRSP contributions provide immediate tax savings

• Investment income from prescribed loan portfolio taxed at spouse’s lower rate

• Trust distributions deferred until children meet exclusion tests

Scenario 3: Tech Startup in the GTA

Facts:

• Founder owns software company generating $1.2M profit

• Adult son (age 26) works as lead developer (50+ hours/week, 5 years in business)

• Daughter (age 23) in university, not involved in business

Strategy:
1. Son: Issue 15% equity ownership + salary of $110,000 (market rate for senior developer in GTA)
2. Dividends to son: Qualifies for TOSI exclusion (substantial involvement + ownership)
3. Daughter: No direct income splitting until age 25 and meets exclusion tests

Tax Outcome:

• Son’s dividends are tax-efficient and TOSI-exempt

• Daughter can be brought into ownership structure post-graduation if involved in business

• Family saves ~$80,000 annually vs. founder taking all income

Working with a CPA for Income Splitting Compliance

Income splitting involves complex interplay between:

• Corporate law (share structure, corporate minute books)

• Tax law (TOSI, attribution rules, reasonableness tests)

• Family dynamics (succession, fairness, control)

• Estate planning (wills, trusts, insurance)

A qualified CPA with expertise in family business taxationsuch as Insight Accounting CPA in Mississaugacan:

Assess your current structure for TOSI compliance risks
Design compliant income splitting strategies tailored to your family and business
Prepare corporate reorganizations (share issuance, trusts, holding companies)
Document all planning steps to withstand CRA scrutiny
File required elections and forms (T1206, T2057, etc.)
Integrate income splitting with succession and estate planning

Frequently Asked Questions

1. Can I pay dividends to my spouse who doesn’t work in the business?

Yes, but only if:

• Your spouse owns at least 10% of the votes and value in the corporation, or

• Your spouse contributed capital and receives only a “reasonable return” on that capital, or

• Your spouse worked substantially in the business in the current or any five prior years

Otherwise, the dividends will be subject to TOSI and taxed at the top marginal rate.

2. Do TOSI rules apply to my 20-year-old child working full-time in the business?

TOSI applies to individuals aged 1824 unless they meet an exclusion. If your child works 20+ hours per week on a regular and continuous basis, they likely qualify for the “excluded business” exemption, and dividends or partnership income can be distributed tax-efficiently.

3. What is a “reasonable” salary for a family member?

A reasonable salary reflects what an arm’s-length employee would earn for the same role, hours, and responsibilities. Factors include:

• Industry and regional benchmarks (e.g., GTA market rates)

• Employee qualifications and experience

• Duties and hours worked

• Formal job descriptions and employment agreements

Overpaying family members invites CRA challenges and potential reassessment.

4. Can I use income splitting if I’m a sole proprietor?

Sole proprietors cannot pay themselves a salary or issue dividends. However, you can:

• Employ family members and pay reasonable wages

• Use prescribed rate loans for investment income splitting

• Contribute to spousal RRSPs

• Incorporate and implement corporate income splitting strategies

5. How does the CRA detect abusive income splitting?

CRA uses data matching and risk assessment algorithms to identify:

• High dividends paid to family members with little or no business involvement

• Salaries that are disproportionate to roles or hours

• Missing or incomplete payroll records

• Patterns inconsistent with arm’s-length arrangements

Proper documentation and professional CPA guidance minimize audit risk.

6. Can I retroactively fix income splitting that doesn’t comply with TOSI?

If you’ve been paying dividends to family members who don’t qualify for TOSI exclusions, you may:

• File adjusted T1 returns for affected individuals

• Pay the additional TOSI tax owing (plus interest)

• Consider the Voluntary Disclosures Program (VDP) if the non-compliance was not previously identified by CRA

Early intervention and professional CPA support are critical.

Conclusion: Maximize Tax Savings with Compliant Income Splitting

Income splitting remains one of the most powerful tax planning tools for family-owned businesses in Ontariobut only when structured to comply with TOSI rules and CRA expectations. By engaging family members in meaningful business roles, documenting contributions, and following the exclusionary tests, you can achieve significant tax savings while building long-term family wealth.

Whether you operate a manufacturing company in Mississauga, a professional corporation in Toronto, or a multi-location service business across the GTA, expert CPA guidance ensures your income splitting strategies are both effective and audit-proof.

Ready to optimize your family business tax strategy?

Call Insight Accounting CPA at (905) 270-1873

Our team specializes in family business tax planning, TOSI compliance, and corporate reorganizations for Ontario businesses. We help you navigate the complexities of income splitting, protect your wealth, and build a sustainable succession plan.

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About the Author

Bader A. Chowdry, CPA, CA, LPA, is the founder of Insight Accounting CPA Professional Corporation, serving businesses across Mississauga, Toronto, and the Greater Toronto Area. With expertise in family business taxation, corporate restructuring, and AI-enhanced financial advisory, Bader helps business owners maximize after-tax wealth and build generational success.

Insight Accounting CPA | Mississauga, ON | (905) 270-1873 | info@insightscpa.ca