By OptiVal Editorial Desk
For years, splitting income through a family corporation was one of the simplest tax moves available to a Canadian business owner. You earned the money, your spouse and adult children held shares, and dividends spread across the family lowered the total tax bill. On January 1, 2018, the tax on split income, better known as the TOSI Canada rules, shut most of that down. If you pay dividends to family members who do not genuinely earn them, the Canada Revenue Agency can tax that income at the top marginal rate, which is about 53.5 percent in Ontario for 2026. That turns a tax-saving strategy into an expensive surprise.
TOSI Canada: what the tax on split income actually is
TOSI sits in section 120.4 of the Income Tax Act. Before 2018, only the “kiddie tax” applied, and it only caught income paid to minors. The 2018 expansion brought adults into the net: spouses, common-law partners, adult children, and certain trusts and partnerships connected to your business.
If you are a “specified individual” (a Canadian resident related to the person whose business generated the income) and you receive “split income” from a related business, that income is taxed at the highest marginal rate instead of your own rate. The top federal rate alone is 33 percent, and combined with Ontario tax it lands around 53.5 percent. Most personal tax credits cannot reduce TOSI, and the amount is calculated on Form T1206 and reported on line 40424 of the federal return.
To put that in perspective: a $50,000 dividend paid to a spouse who earns $100,000 might otherwise face a marginal rate of about 31.5 percent in Ontario, roughly $15,750 of tax. Under TOSI, the same $50,000 is hit at roughly 53.5 percent, about $26,750. That is roughly $11,000 extra tax on the same payment, before any interest or penalties. (Illustration only, using 2026 Ontario combined rates.)
What counts as split income
TOSI does not catch every dollar a family member receives. It catches specific types of income from a “related business”, meaning a business carried on by someone you are related to. The main triggers:
- Dividends on shares of a private corporation where a related person is involved in the business. This is the most common trigger.
- Income from a partnership or trust where a related person is a specified individual in respect of the business.
- Income from debt obligations of a related business, such as interest on a loan to the family company.
- Certain capital gains on the disposition of property, though gains eligible for the lifetime capital gains exemption and gains arising on death are carved out.
One important boundary: a genuine salary for genuine work is not split income. The salary must be reasonable for the work performed, and it is deductible to the company. The problem only starts when money flows to family members who have not earned it.
The four exclusions that matter most
The legislation calls these “excluded amounts”: income that looks like split income but escapes TOSI. Nearly every planning conversation comes down to these four.
1. The excluded business: the 20-hour rule
If the recipient is 18 or older and was actively engaged in the business on a regular, continuous, and substantial basis, the income is excluded. CRA guidance treats an average of at least 20 hours per week during the part of the year the business operates as meeting the test. The five prior years count too, and they do not need to be consecutive, so a spouse who worked full time in the business a decade ago and retired can still qualify.
Occasional help does not cut it. Answering the odd phone call or signing documents once a year will not survive a review. Keep time records and a job description if you plan to rely on this one.
2. Excluded shares
A recipient who is 25 or older and personally owns shares representing at least 10 percent of both the votes and the value of the corporation can receive dividends on those shares free of TOSI, with conditions. The corporation cannot be a professional corporation, it must earn less than 90 percent of its business income from providing services, and substantially all of its income must come from its own business rather than a related one.
This exclusion fails more often than owners expect. Service businesses are deliberately shut out, and the 10 percent test applies to both votes and value. Share structure and documentation need to be right before the dividend is paid, not after.
3. The reasonable return test
For recipients 25 or older, an amount is excluded if it represents a reasonable return on what they contributed: labour, capital, business risk assumed, and amounts previously paid. For recipients between 18 and 24, the test is tighter: only a “safe harbour capital return” (a prescribed-rate return on arm’s length capital they actually contributed) or a reasonable return on that capital qualifies.
Reasonableness is judged on the facts, and the CRA will look at documentation. A 22-year-old who contributed nothing and performed no work has a very short runway.
4. The age-65 spousal exclusion
If the source individual, the person whose business generated the income, is 65 or older in the year, amounts received by their spouse or common-law partner are excluded. This was designed to line up with pension income splitting, so business owners are not worse off in retirement than pensioners. Amounts received after the source individual’s death can also qualify under related rules.
The traps owners fall into
Owning shares is not enough. Simply holding shares in the family company does not protect the dividends. The shares and the income must fit one of the exclusions above.
Family trust allocations get caught too. Allocating dividends or business income through a discretionary family trust to adult children who do not work in the business is a classic TOSI fact pattern. The trust does not launder the income out of the rules.
Artificial fixes invite the general anti-avoidance rule. Paper transactions designed to manufacture an exclusion, such as contrived share structures with no commercial purpose, can attract GAAR on top of TOSI. If a structure only exists on paper, the CRA can look straight through it.
The paperwork comes first. Every exclusion above depends on facts you can prove: hours worked, share registers showing the 10 percent test, capital actually contributed. Reconstructing this during an audit is a losing game.
What to do if you think TOSI applies to you
Start with the CRA’s own material: the federal tax on split income page explains how the amount is calculated on Form T1206 and reported on line 40424 of the T1. Then map every dividend or allocation paid to family members against the four exclusions above. If none fits cleanly, the planning question is not how to defend the dividend, it is whether to pay it at all.
TOSI rewards substance and punishes paperwork-only planning. Family members who truly work in the business, hold a real ownership stake, or receive income after age 65 have clear paths through the rules. Everyone else is paying the top rate. If your family dividend strategy was set up before 2018 and has not been reviewed since, now is the time.
For related reading, see our guides on income splitting with your spouse in Canada and how an estate freeze works for incorporated owners.
This article is general information for educational purposes. It is not financial advice and does not recommend any specific investment. Consider speaking with a licensed professional about your own situation.
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