TAX ON SPLIT INCOME (TOSI)

Tax on Split Income (TOSI): Understanding the Rules

The Tax on Split Income (TOSI) applies when a family member receives income from a related business with the intention of reducing taxes. This can include certain taxable dividends, taxable capital gains, and income from partnerships or trusts.

The primary taxpayer may benefit by lowering taxable income by sprinkling income to family members in lower tax brackets. However, if the income is deemed subject to TOSI rules, it will be taxed at the highest marginal tax rate, which is currently 33%.

Example: If a child receives dividends from a family business and TOSI applies, the income is taxed at the highest rate.

Exclusions to TOSI

Excluded Business: Spouses or children (18+) actively engaged in the business (20+ hours/week) can avoid TOSI.

Excluded Shares: Shares owned by individuals aged 25 or older, who hold at least 10% of both voting shares and value, can avoid TOSI.

Return on Safe Harbor Capital: Family members over 25 can avoid TOSI if the income is a reasonable return on capital invested in the business.

Taxpayers with Spouses Aged 65 or Older: Senior business owners can split income with their spouse without worrying about business involvement or share qualifications.

What is Safe Harbor Capital Return?

A return up to the prescribed interest rate on the fair market value (FMV) of the property contributed by a family member to a related business. For example, if a child contributes $1,000 to a business and the highest prescribed rate is 5%, the safe harbor return is $50. If the child's income does not exceed this amount, TOSI does not apply.

To apply the TOSI rules, you must complete Form T1206 – Tax on Split Income to determine the TOSI-adjusted taxable income.

Conclusion

Income splitting is a popular tax strategy for business owners, but understanding TOSI and attribution rules is crucial to avoid unintended taxes and penalties. Given the complexity of these rules, it’s advisable to consult with professional tax advisors before implementing these strategies.

For more information, visit the official page: Canada Revenue Agency - Tax on Split Income