Income Splitting and TOSI: What Canada's Tax on Split Income Rules Mean for Families

If you own a private corporation in Ontario and you've heard the phrase "income splitting," you've probably also heard the phrase "TOSI." The two are now inseparable — and understanding how the Tax on Split Income rules work is essential before you decide how to pay family members from your business.

Income splitting used to be one of the most popular tax-planning moves available to Canadian business owners. The idea was simple: shift income from a high-earning family member to a lower-earning spouse or adult child, take advantage of their lower marginal tax bracket, and reduce the family's total tax bill. For years, private corporation owners used dividends to do exactly this.

Then, in 2018, the federal government significantly tightened the rules. The TOSI regime — Tax on Split Income — extended rules that had long applied to minor children and aimed them squarely at adult family members receiving dividends or other income from private companies. The result is that income splitting through a corporation is now much harder to do, and getting it wrong can be very costly. Here is what you need to know.

What Is Income Splitting — and Why Did It Matter?

Canada's income tax system is progressive: the more you earn, the higher your marginal rate. If one family member earns $300,000 and another earns $30,000, the family as a whole pays far more tax than if that income were spread more evenly.

Income splitting exploits the gap between family members' marginal rates. In the context of a private corporation, an owner could issue shares to a spouse or adult child, declare dividends on those shares, and effectively move income from the high-income owner's hands into the family member's lower-taxed hands. This practice is sometimes called "dividend sprinkling."

For business owners with a spouse who was not otherwise earning significant income, or with adult children in school, the savings could be substantial — often tens of thousands of dollars per year. It was entirely legal under the old rules, and it was widely used across Ontario and the rest of Canada.

What Is TOSI (Tax on Split Income)?

TOSI stands for Tax on Split Income. It is a provision in the Income Tax Act that taxes certain types of "split income" at the highest marginal personal tax rate — regardless of the actual income of the person receiving it.

In other words: if TOSI applies, it does not matter that your spouse is in a low bracket or that your adult child earned very little that year. The income is taxed as if they were a high earner. As of writing, Ontario's top combined federal-provincial marginal rate is among the highest in the country — confirm the current rate with CRA or your accountant, as rates change from year to year. The point is that TOSI eliminates the tax-rate advantage entirely.

TOSI is not a new concept. A version of it — commonly called the "kiddie tax" — applied to minor children for years. The 2018 changes dramatically expanded the regime to capture adults as well.

Who Does TOSI Apply To?

Adults in the Family (Age 18+)

This is where the 2018 changes hit hardest. TOSI now applies to adult family members — including spouses, adult children, siblings, and parents — who receive income from a private corporation in which a related person has an interest.

The central question is whether the adult receiving the income is genuinely contributing to the business. The rules ask whether the amount received is "reasonable" in light of the work actually performed, the property contributed, or the financial risk assumed. If it is not reasonable — if the income is really just a tax-reduction payment dressed up as a dividend — TOSI kicks in.

Myth: "My spouse is a shareholder, so any dividend they receive is fine."

Reality: Holding shares is not enough. If your spouse is not actively involved in the business, not taking on meaningful financial risk, and not providing services worth the amount being paid, TOSI almost certainly applies to their dividends.

Minor Children (Under 18)

The rules for minors are even stricter. Split income paid to a child under 18 is essentially always subject to TOSI. There are very narrow exceptions — for instance, if the income flows from the death of a parent — but for practical purposes, paying business income to a minor child to reduce the family's taxes does not work. It has not worked for a long time.

What Income Is Caught by TOSI?

TOSI applies to a defined list of "split income" types. The most common categories for private corporation owners include:

• Dividends (or shareholder appropriations treated like dividends) from a private corporation, where a related person is connected to that corporation
• Income from a partnership or trust that derives from the business of a connected person
• Capital gains from the disposition of shares of a private corporation to a related person (in some circumstances)

Interest payments are generally not caught by TOSI in the same way, but the rules are technical and the exceptions matter. When in doubt, get specific advice.

Excluded Amounts: When TOSI Doesn't Apply

The Income Tax Act carves out a number of "excluded amounts" — situations where TOSI does not apply even though the income would otherwise qualify as split income. These exclusions are what determine whether any income splitting remains available for your family.

Key exclusions for adults (18+):

• Reasonable salary for actual work: If the family member is paid employment income for genuine work they perform in the business, and that salary would be paid to an unrelated employee doing the same work, TOSI does not apply to that salary. The amount must be defensible.
• Active engagement in the business: If the adult family member is actively engaged in the business on a regular, continuous, and substantial basis — a commonly cited benchmark in practice is an average of at least 20 hours per week during the year — their income may be excluded. This is a facts-and-circumstances test that CRA takes seriously.
• Age 65 and over: Special rules apply to spouses who are 65 or older. Income paid to an older spouse may be excluded from TOSI in certain circumstances, which partially preserves income splitting at retirement age.
• Capital contributed at fair market value: If an adult family member contributed property to the business at fair market value, returns on that contribution may be excluded from TOSI, subject to conditions.

Myth: "My adult daughter is listed as a co-owner, so her dividends are fine."

Reality: Being named as a shareholder on paper is not sufficient on its own. What matters is what she actually does — work performed, risk taken, capital contributed — and whether the amount paid to her is reasonable for that contribution.

Income Splitting Strategies That Still Work

TOSI did not eliminate every form of income splitting. Several legitimate strategies remain available to Ontario families:

• Spousal RRSP contributions: A higher-income spouse can contribute to an RRSP in the lower-income spouse's name. At retirement, withdrawals are taxed in the lower-income spouse's hands. This remains one of the most effective long-term income-splitting tools in Canada, and TOSI does not touch it.
• Pension income splitting: Couples where one or both partners receive eligible pension income can allocate up to half of that income to the lower-income spouse at tax time. This is a direct CRA election — no corporate structure required.
• Paying a reasonable salary to a working spouse: If your spouse genuinely works in your business, paying them a fair market salary for their actual work is still valid and is not caught by TOSI. The salary must be real, documented, and defensible for the role.
• Adult children who genuinely work in the business: If an adult child works in the business full-time — performing meaningful work, regularly and continuously — their employment income or dividends (to the extent they reflect reasonable compensation) can fall outside TOSI.
• Investing in the lower-income spouse's name: Investment income earned on assets held in the lower-income spouse's hands is generally taxed in their hands, subject to the separate attribution rules under the Income Tax Act. This is distinct from the corporate context and can still play a useful role in long-term planning.

What This Means for Your Family Business

If you run a private corporation in Ontario and have been paying dividends to family members, it is worth reviewing your structure in light of the current TOSI rules. A few practical points:

The days of dividend sprinkling to non-working family members are largely over. If your spouse or adult child is not genuinely contributing to the business, paying them dividends will likely trigger TOSI and wipe out any tax benefit — while also attracting CRA scrutiny.

Documentation matters more than ever. If a family member is actively engaged in the business and you want to rely on the active engagement exclusion, keep records. Employment contracts, timesheets, job descriptions, and evidence of actual work performed are all useful when CRA comes asking.

The legal structure and the tax filing are two separate things. A lawyer can help you structure how shares are held, whether a family trust makes sense for your situation, and whether your shareholder agreements reflect the actual roles and risks of each family member. Your accountant then ensures the tax reporting aligns with that structure and that any applicable TOSI exclusions are properly claimed. These two professionals should be working from the same picture — and they should be talking to each other before you file.