Tax on Split Income (TOSI) is designed to prevent family members from reducing overall taxes by splitting income from a related business. TOSI generally applies to income from certain dividends, capital gains, partnerships, or trusts received by family members who haven't sufficiently contributed to the business.
Income splitting involves allocating income to family members in lower tax brackets, reducing the primary taxpayer’s tax burden. When TOSI applies, any split income is taxed at the highest marginal rate of 33%.
Example: If a child receives dividends from a family-owned company, TOSI rules may tax this income at the highest rate. TOSI applies to all related adults not making substantial business contributions, as expanded by the Government of Canada on January 1, 2018.
Exclusions from TOSI
TOSI rules do not apply in some cases. Here are the primary exclusions:
1. Excluded Business: TOSI is avoided if a family member aged 18 or older is regularly engaged in the business, working at least 20 hours per week.
2. Excluded Shares: Income or gains from shares held by individuals aged 25 or older may be exempt if they own at least 10% of the voting shares and company value. Additionally, 90% or less of the business’s income should come from services, and 90% or more of total income should not come from related businesses.
3. Return on Safe Harbor Capital: For family members over 25, TOSI may not apply if income represents a reasonable return on their investment.
4. Spouses Aged 65 or Older: A senior business owner can split income with their spouse without needing them to meet excluded share requirements or safe harbor conditions.
Example of Safe Harbor Return
If a child contributes $1,000 to their parent's business, and the highest prescribed interest rate is 5%, their safe harbor return is $50 ($1,000 x 5%). If the child’s income from this investment does not exceed $50, TOSI does not apply.
Taxpayers should complete Form T1206 to calculate TOSI-adjusted income. Income splitting remains a popular tax strategy, but understanding TOSI rules is essential to avoid unexpected tax liabilities and penalties.
Posted on 14 November 2024