Family Trusts and Income Splitting in Ontario: The Basics

For business owners and families with investment income, a family trust has long been a planning tool for distributing income among family members in lower tax brackets — a strategy called income splitting. If you have ever heard an accountant mention "putting money through the trust," this is what they mean.

But Canadian tax rules have tightened significantly. The Tax on Split Income (TOSI) rules, introduced in 2018, fundamentally changed who can benefit from income earned through a family trust. Before setting one up — or continuing to rely on an existing one — Ontario families need to understand what a family trust actually is, what it can and cannot do today, and how it fits into a broader estate plan.

What Is a Family Trust?

A family trust is an inter vivos discretionary trust — meaning it is set up during your lifetime (not by your will) and gives the trustee discretion over how and when income and capital are distributed to beneficiaries.

Typical structure:

• Settlor: the person who creates and initially funds the trust (often contributes a small amount)
• Trustee: the person (often the business owner or a family member) who manages the trust and exercises distribution discretion
• Beneficiaries: typically the settlor's spouse, children (adult and minor), and sometimes a holding corporation — a broad class that maximizes flexibility

Assets are usually transferred into the trust by way of a loan at the prescribed rate of interest (set by CRA — verify the current rate), or through the sale of property to the trust. In business contexts, shares of a private corporation are often the primary trust asset.

How Income Splitting Through a Trust Works

The theory is straightforward: if a trust earns $100,000 in investment income or dividends and distributes $20,000 each to five family members in lower tax brackets, the total tax paid is less than if one person with a high income received all $100,000 and paid tax at the top marginal rate.

The trust itself does not pay tax on amounts it distributes — instead, the income is taxed in the hands of the beneficiary who receives it (assuming the income is properly designated and distributed).

This only produces a tax saving if the beneficiary actually is in a lower bracket and the TOSI rules don't apply.

The TOSI Rules: What Changed in 2018

The Tax on Split Income rules, commonly called TOSI, were significantly expanded in 2018. Where TOSI applies, split income is taxed at the top marginal rate in the hands of the recipient — eliminating the tax benefit of distributing to a lower-income family member.

TOSI broadly applies to income distributed through a trust to:

• Minor children (under 18) from business income or taxable capital gains — this was always the case
• Adult children, spouses, or other adult family members who are not meaningfully involved in the business

Exemptions exist where an adult family member is:

• A reasonable contributor (meaning they work in the business for a substantial number of hours, as of writing — verify the current threshold with CRA)
• A spouse of the business owner who is aged 65 or older
• A person meeting one of several other statutory exceptions

The rules are detailed and the exemptions are fact-specific. A tax professional is essential before any income splitting through a family trust is relied upon. The rules have been refined since 2018 and you should verify current CRA guidance.

What Family Trusts Can Still Do Well

Despite the TOSI restrictions, family trusts remain useful for several purposes:

1. Multiplying the Lifetime Capital Gains Exemption

When qualifying small business corporation shares (shares of a Canadian Controlled Private Corporation meeting the conditions in the Income Tax Act) are sold, each individual can claim a capital gains exemption up to the lifetime limit (as of writing — verify current amount with CRA). A family trust that holds shares and allocates the capital gain to multiple adult beneficiaries who each meet the exemption conditions can significantly reduce tax on a business sale. TOSI generally does not apply to capital gains that qualify for the lifetime exemption.

2. Asset Protection

Assets held in a trust are not owned by the beneficiaries — so they may be less accessible to a beneficiary's personal creditors or in a divorce. This is not ironclad protection and depends on how the trust is structured and funded.

3. Estate Freeze

Family trusts are a common component of an estate freeze — a strategy where a business owner freezes the current value of their business in their own hands and allows future growth to accrue in a trust for the benefit of the next generation. This is a sophisticated tax and succession planning strategy that requires professional advice.

4. Succession and Control

A trust allows a business owner to give family members economic benefits (distributions) while the trustee retains control over the business. This can bridge the gap while children mature into leadership roles.

Estate Planning Implications

A family trust created during your lifetime interacts with your estate plan. Assets in the trust at your death do not form part of your estate — they continue in the trust under its existing terms, eventually flowing to beneficiaries as the trust deed provides. This means probate is avoided on trust assets, but also means your will does not control them.

Every 21 years, a trust is deemed to have disposed of its assets at fair market value — triggering capital gains. This is the 21-year rule, and trustees of long-standing trusts need to plan well in advance to address it (by distributing assets, winding up the trust, or other strategies). Consult a tax professional well before the 21-year mark.

Frequently asked questions