As of January 01, 2019, the federal government implemented an expanded Tax on Splitting Income (TOSI), which had significant implications for small business owners and their families. Prior to 2019, they enjoyed certain tax benefits that were no longer available due to the new rules.
To help you understand how these changes will affect you, we’ve outlined some steps you can take in light of the government’s revised TOSI rules.
In Canada, income splitting is a tax strategy used to lower a taxpayer’s overall tax bill by assigning income to lower-income family members. This takes advantage of Canada’s progressive tax system, which imposes higher tax rates on higher income levels. By allocating income to lower-income family members, taxpayers can effectively lower their taxable income and reduce their tax bill.
There are various methods and rules for income splitting in Canada, such as spousal loans, family trusts, and investment income splitting. However, it’s crucial to follow Canada’s tax laws and regulations when employing these strategies, as the CRA has rules in place to prevent taxpayers from using income splitting to artificially reduce their tax bill. Taxpayers who engage in improper income splitting may face penalties and fines.
If you’re seeking tips to reduce taxable income in Canada, income splitting can be an excellent option.
How Does Income Splitting Work in Canada Now?
Income Splitting in Canada has changed significantly since 2018. Previously, the Tax on Split Income (TOSI) rules only applied to individuals under 18 who were splitting income gains. However, as of January 1, 2019, the split income of those over 18 will also be subject to TOSI.
Under the revised TOSI rules, the Canada Revenue Agency (CRA) will tax the split income of all persons over 18 at the highest marginal tax rate. This means that taxpayers can no longer take advantage of lower tax rates by splitting income with a family member in a lower tax bracket.
Despite these changes, there are still some exceptions to the income-splitting law in Canada that business owners can leverage. However, it’s important to note that these exceptions only apply to immediate family members, such as parents, children, or siblings, and not extended family members like aunts, uncles, nephews, or nieces.
What Income Splitting Exceptions Exist for TOSI in Canada?
There are several situations where individuals can be exempt from the Tax on Split Income (TOSI) rules in Canada. These are:
1. Excluded Business Gains
If a family member between the ages of 18-24 has worked for an average of at least 20 hours per week with the business in the current tax year or can show this requirement for any 5 previous taxation years, their gains are exempt from TOSI. This exemption also applies if the business only operates for part of the year. Additionally, dividend earnings made after this period are also exempt, making it useful to convert a sole proprietorship into a corporation. For instance, if a child worked at their parents’ bakery from 19 to 24, then earned dividends from 25 to 28, those dividends would be exempt from TOSI if they are deemed ‘reasonable.’
2. Excluded Shares
If a relative aged 25 or older owns at least 10% of the company in both votes and value, their dividends are exempt from TOSI. However, this exemption only applies to corporations that earn less than 90% of their income from the provision of services and are not professional corporations, such as law firms or accounting firms.
3. Other Exemptions
Business owners aged 65 and over who make contributions to the business can split income with their spouse without being subject to TOSI. Additionally, gains from selling shares in a qualified small business, farm, or fishing property are exempt from TOSI.
It’s important to note that while these exemptions exist, taxpayers must adhere to Canadian tax laws and regulations. Taxpayers who engage in improper income splitting to reduce their tax bill may face penalties and fines.
The recent changes to the TOSI exemption rules are not only complex, but they may also undergo further modifications in the future. With various gray areas such as what constitutes an “unreasonable return” and the documentation requirements for family members’ involvement in the business, businesses must be careful not to leave anything to guesswork. Unfortunately, this means that many companies will need to realign their operations to comply with the expanded TOSI framework.
While this article provides a brief overview of the issue, each business is unique, and specific questions may arise. Therefore, it is recommended to consult with an accounting firm that is familiar with the legal environment and the specific needs of your small business.
Whether you need help managing your regular tax needs or adjusting your organizational structure to take advantage of new tax laws such as TOSI, we at SRJCA are here to assist you. We will help you understand your tax obligations, allowing you to focus on growing your business. Contact us today for more information.
Here are some frequently asked questions about income splitting in Canada:
1. Who is eligible for income splitting in Canada?
Eligibility for income splitting in Canada depends on factors such as age and type of pension received. For instance, Canadians over the age of 65 who do not receive certain credits such as CPP (Canada Pension Plan) can split their income from qualifying payments like RRSP and RRIF. However, those under 65 years are only eligible for pension splitting on certain life annuity payments or in the event of a spouse’s passing.
2. What is income splitting in Canada?
Income splitting is a tax strategy that Canadians use to decrease their tax burden by assigning income to lower-earning family members. By taking advantage of the progressive tax system in Canada, where higher tax rates apply to higher income levels, taxpayers can effectively lower their overall taxable income and reduce their tax bill.
3. Is income splitting allowed for 2023?
Yes, income splitting is still allowed in Canada in 2023. However, there are new TOSI (tax on split income) rules, which now apply to those over the age of 18. Previously, it only applied to those under 18. These rules could impact many families who have previously split income with their children, but there are exceptions. For example, those between 18-24 who worked at least 20 hours per week have their gains exempted from TOSI. If you have any specific questions about income splitting, it’s best to speak with an accounting firm that understands the legal environment and can address your small business’s needs. Contact SRJCA today to learn more about managing your business’s tax obligations and leveraging new tax laws like TOSI.
4. Can individuals in Canada splitting their income?
To be eligible for income splitting in Canada, both an individual and their spouse must be residents of Canada by the end of the calendar year, unless for reasons such as work or school.
5. What is income splitting in Canada, and how does it work?
Income splitting is a tax strategy used in Canada to allocate income to lower-income family members and take advantage of the country’s progressive tax system. By doing so, taxpayers can effectively reduce their overall taxable income and lower their tax bill. The higher-earning spouse transfers income to the lower-earning spouse, who is typically in a lower tax bracket. This allows more taxable income to be in the lower earner’s hands, reducing the family’s overall tax burden.
6. Are there any regulations around income splitting in Canada?
Income-splitting strategies in Canada must comply with the country’s tax laws and regulations. The Canada Revenue Agency has rules in place to prevent taxpayers from artificially reducing their tax bill through improper income splitting, and individuals who engage in such practices may face penalties and fines. For high-income earners, it’s worth exploring tax planning tips for Canadian doctors and other professionals to ensure compliance with tax laws and maximize tax savings.
7. How does income splitting work for seniors in Canada?
Income splitting for seniors in Canada involves transferring income to a lower-income spouse or common-law partner to take advantage of their lower tax rates. This can be accomplished through pension income splitting, spousal loans, or investment income splitting. By reducing their combined taxable income, seniors can lower their overall tax bill and maximize their retirement savings. However, it’s essential to ensure that any income-splitting strategies used comply with Canadian tax laws and regulations.
8. Do both spouses have to be 65 to income split?
No, the receiving spouse does not have to be 65 years of age or older. Additionally, the amount split can be changed on a yearly basis to benefit the couple.
9. What are the benefits of income splitting in Canada?
Income splitting in Canada can enable families with low and high earners to save money on taxes by distributing their income evenly.
10. Is income splitting legal in Canada?
Yes, income splitting is legal, but depending on the recipient’s age and credits, a Tax on Split Income (TOSI) may apply.