Income Splitting Through Your Corporation: What Business Owners Need to Know
As a business owner, you might be considering income splitting as a way to reduce your family’s overall tax burden. While this can be an effective strategy, Canada’s tax rules—particularly the Tax on Split Income (“TOSI”) regulations—impose strict limits on how and when it can be done. Missteps can lead to significant tax consequences, so it’s essential to understand the rules before proceeding.
What Is Income Splitting Through a Corporation?
Income splitting through a corporation involves distributing income to family members who are in lower tax brackets to reduce the overall taxes paid by the family. Common methods include paying dividends or salaries to spouses or children. While income splitting can be beneficial, TOSI rules have made it far more challenging for business owners to use this strategy without triggering penalties.
Why Is This Important?
When done properly, income splitting can provide significant tax savings. Here are a few key situations where it might still work:
- Family members actively contributing to the business: If your spouse or children meaningfully contribute (min 20 hours a week on average) to the operation of your business, paying them reasonable compensation for their work is allowed.
- Excluded amounts under TOSI: TOSI exemptions may apply if the income is:
- Paid to family members over age 18 who own at least 10% of a corporation’s shares (in non-service businesses).
- Paid to a spouse who is over 65 years old.
- Derived from excluded business activities, such as meaningful involvement in the business’s daily operations.
What Are the Risks and Consequences?
While income splitting might seem straightforward, failing to comply with the rules can lead to significant tax consequences:
- TOSI Penalties: Any ineligible income paid to family members will be taxed at the highest marginal rate, which can significantly increase your overall tax bill.
- CRA Reassessments: If the Canada Revenue Agency (CRA) determines that payments to family members were ineligible for TOSI exemptions, they may reassess your taxes, leading to retroactive payments and interest.
- Lost Tax Benefits: Improperly structured income splitting can nullify potential tax savings and leave you paying more than you intended.
How Business Owners Can Navigate TOSI Rules
While TOSI has added complexity, there are still legitimate ways to use income splitting effectively. Here are a few strategies to consider:
- Pay reasonable salaries for legitimate work: Ensure that family members are compensated fairly for actual work performed for the business. Keep documentation to support their contributions.
- Meet TOSI exemption criteria: Review your corporate structure to see if family members qualify for TOSI exclusions.
- Plan ahead: Work with a CPA to assess whether income-splitting strategies align with your financial and tax goals.
Why This Matters
For many business owners, income splitting can be a valuable tool to reduce taxes and improve overall financial efficiency. However, the rules are complex, and the consequences of getting it wrong can be costly. Understanding the nuances of TOSI and consulting with a professional can ensure that you maximize your tax savings while staying fully compliant with CRA regulations.
How We Can Help
Navigating income-splitting rules for corporations requires expertise and careful planning. As CPAs, we can:
- Analyze your business structure and determine eligibility for TOSI exemptions.
- Help you structure payments to family members appropriately and within the law.
- Provide tailored tax planning strategies to reduce your overall tax burden.
Income splitting can still be a viable strategy when executed correctly. Reach out today for personalized advice to ensure your business and family finances stay on track.