Canada Income Splitting

The Canadian federal government introduced significant changes to the Tax on Split Income (TOSI) rules effective January 01, 2019. The recent alterations have considerably affected small business proprietors and their loved ones, as numerous tax flexibilities that were once accessible to them have now been removed.

If you are a small business owner or related to one, be aware that the revised TOSI regulations will impact you. However, it is feasible to reduce the impact of the modified TOSI regulations on your tax status by implementing some strategies.

In this article, we will thoroughly examine the consequences of these changes on your financial status and offer plausible recommendations to alleviate their influence.

What Does the Term Income Splitting Mean?

Income splitting has been increasingly utilized as a tax-saving tactic in Canada. The strategy aims to assign revenue to lower-earning relatives to lower the taxpayer’s overall tax burden. The Canadian tax system operates progressively, meaning individuals with more income are subjected to higher tax rates.

To diminish their taxable revenue and subsequent fiscal obligation, taxpayers can allocate funds among family members with a lesser income and face a decreased tax rate. This technique is commonly known as child benefits for dependent relatives experiencing tough economic times or reduced cash flow levels.

It is of utmost importance to consider that specific limitations and statutes govern the practice of income splitting, necessitating taxpayers’ thorough assessment of said regulations before their implementation. We advise taxpayers to seek a tax expert’s guidance before implementing this strategy.

List of methods and rules for income splitting in Canada:

Family Trusts

A trust for families capable of providing significant tax benefits in Canada would be none other than the family trust. Taxpayers may lessen their entire expense summary by portioning pay from said trust to various members within a household circle.

When giving income, it could allow an advantage particularly useful when benefiting lower-income recipients who might have rate differences compared to primary earners regarding taxes accomplished on them.

By forming a trust for the family, it is possible to allocate income from the fund with excellent tax efficiency, which in turn helps families maximize their earnings. Creating such trusts can be instrumental when seeking ways to reduce taxes and handle finances more efficiently.

Spousal Loans

One method for income splitting in Canada is using Spousal Loans. This process involves lending money to a lower-income spouse or common-law partner and charging interest. The lower-income spouse can claim the interest income and effectively split the taxpayer’s income.

A widely used tactic by Canadian taxpayers involves transferring income from the higher-earning party to the lower-income individual, thereby causing a decrease in their collective taxes.

This plan is especially advantageous for couples with one partner earning substantially more than the other since it can even out their earnings and alleviate taxation woes. However, it is essential to note that this strategy must be implemented correctly and comply with tax laws to avoid penalties or fines.

Investment Income Splitting

Income splitting is a tax planning strategy that can provide significant benefits for families in Canada. One way to split income is to hold investments in the names of lower-income family members, allowing them to claim the income generated. The taxpayer can effectively split their income and reduce their overall tax bill.

This technique proves advantageous for households with a primary breadwinner in an elevated tax tier. Families can pocket considerable savings on their levies by directing revenue to family members who incur lower taxes.

Upon consideration of the whole picture, redistributing income by way of investments presents itself as an invaluable instrument for those seeking to lessen their fiscal obligations and raise post-tax profits.

It must be kept in mind that techniques for splitting income should align with the tax laws and regulations of the nation.

The Canadian Revenue Agency (CRA) has implemented guidelines to prevent taxpayers from inappropriately using income-splitting strategies, thereby decreasing their taxes payable. CRA closely monitors these specific rules, and those individuals who participate in improper income splitting may face retributory fines or penalties.

Selecting income splitting as a technique to curtail one’s taxable earnings comes with various merits. However, individuals must ensure their preferred maneuvers fall within Canadian tax regulations.

For this purpose, taxpayers are best served by working closely with authorized taxation professionals who remain well-versed on the most recent legislative advancements in this field. By doing so, they can legitimately employ various means for distributing their revenues while sidestepping any potential legal predicaments throughout the process.

What is the Current Mechanism of Income Splitting in Canada?

If one is searching for means of minimizing taxes through income splitting, it is imperative to take notice of the recent TOSI modifications. In earlier times, only those below 18 who took advantage of income splitting were subject to TOSI; however, even split wages earned by individuals over eighteen will be accountable to this act.

It is to be assumed that in case of an individual exceeding 18 years, sharing their earnings with a family member will result in taxation according to Canadian tax regulations. The rate applied shall not fall below the maximum marginal bracket for taxes imposed.

Consequently, this could profoundly impact how much you save through splitting your earnings because exploiting lower taxation brackets by sharing them with relatives in those categories would no longer be viable under these circumstances.

Despite the income-splitting law that business proprietors can take advantage of, there are some rare cases. These anomalies permit certain types of enterprises to still profit from splitting their earnings if an immediate family member like a parent, child, or sibling receives it. Remember that these exemptions have constraints and must be utilized following Canada’s tax laws and regulations.

Overall, modifications made to TOSI regulations have restricted prospects for Canadians to benefit from income splitting. Nevertheless, some chances are still available for entrepreneurs who wish to maximize this tax planning methodology. One must seek advice from a qualified taxation specialist to avoid running afoul of Canadian statutes or provisions relating to it.

What Income Splitting Exceptions Exist for TOSI in Canada?

1. Shares that are Excluded

If a familial associate possesses 10% or more of the company’s worth and voting power, coupled with an age threshold over 25, their portion of dividends is liberated from any liability to TOSI. This discovery proves favorable for proprietors keen on preserving business within kinship bonds.

Nonetheless, it should be emphasized that said immunity solely extends towards institutions whose productivity is at most 90% via services rendered, not professional corporations such as law practices, accountancy firms, dentistry, and medical clinics.

The Canadian government implemented this exemption to help small businesses keep ownership within the family. Remarkable attention is required for businesses owned and managed by families since a relation involved in routine business proceedings might unjustifiably exploit this exception.

Further notable details include that family members, friends, and other individuals possessing ample company shares will be covered under this exemption umbrella.

2. Business Gains that are Excluded

In Canada, the Tax on Split Income (TOSI) statute targets individuals over 18 years old and imposes a tax rate at par with their highest possible earnings. Nevertheless, exceptions exist that nullify this law’s application in specific circumstances.

One exception pertains to individuals between 18-24 years old and part of a family unit where a business owner is employed for twenty hours or more per week during this fiscal period. This exemption is handy for families who want to income-split with their adult children attending school or starting their careers.

Additionally, the 20 hours a week requirement can be demonstrated in any five previous taxation years, benefiting businesses that employ family members seasonally. If the business operates only for part of the year, the family member’s work input must be demonstrated only during that period. This requirement helps prevent abuse of the income-splitting rules while providing flexibility for business owners to take advantage of this tax planning strategy.

It’s important to note that earnings made in the taxation years the individual worked and dividend earnings made after that period are also exempt from TOSI. This exemption can be beneficial when converting a sole proprietorship into a corporation, where the business can split income with family members who help with the business.

The provision in question permits relatives to partake in business development and financial affluence, facing substantial fiscal obligations.

If a child has worked at their parents’ business for an average of 20 hours a week and is between 18 and 24, their earnings are exempt from TOSI. Even if they step away from the business’s daily operations, they can still earn exempt dividends if deemed reasonable. This exemption can help owners keep the business in the family and minimize tax liabilities.

One way to take advantage of this exemption is through incorporation. Incorporation can provide numerous benefits for business owners, including limited liability protection, easier access to capital, and potential tax savings.

For example, by incorporating, business owners can pay themselves a salary and take advantage of lower tax rates for active business income. The business owner can also pay dividends to family members who work in the business and take advantage of the TOSI exemptions.

Realtors, in particular, can benefit from incorporation. By incorporating, realtors can separate their liabilities from their business liabilities, which is vital since realtors are often involved in high-stakes transactions.

Incorporation can also provide tax savings opportunities for realtors, who can take advantage of lower tax rates for active business income and dividend income. Overall, the exemption from TOSI and the benefits of incorporation can be powerful tools for business owners and realtors looking to minimize their tax liabilities and protect their assets.

3. Other Known Exemptions

Spousal income splitting is exempt from TOSI for business owners aged 65 and above who have contributed to the business. If a spouse has contributed to the business and the business owner is over 65, any income splitting will not be subject to TOSI. This can benefit business owners who want to ensure their spouse is financially cared for in retirement.

Another exemption from TOSI is the split income from gains from selling shares in qualified business shares, farms, or fishing property. According to the CRA, if the property sold is a qualified farm, fishing property, or shares of an eligible small business, any split income gained from the sale will be exempt from TOSI.

One of the advantageous outcomes that can arise from this is assisting individuals who desire to transfer their business or farm property down to their offspring or other family members.

The Complexity of the New Regulations

Navigating the new TOSI exemption rules can be daunting for business owners. Given the intricate nature of tax codes coupled with potential modifications down the line, it is crucial to possess a comprehensive grasp of taxation regulations.

One of the primary challenges businesses face is determining what constitutes an unreasonable return, as this will determine whether their family members’ income is subject to TOSI. Additionally, businesses must accurately document their family members’ work in the company, which can be challenging without the proper guidance.

To align themselves with the expanded TOSI framework, businesses may need to undertake significant changes, and this process can be overwhelming.

To confront the changes, entrepreneurs must communicate with a firm specializing in accounting that possesses experience and wisdom, enabling them to traverse these modifications. This approach empowers businessmen/women to conform to fiscal regulations while using all possible exemptions.

At JTT Accounting, we understand the complexity of the TOSI exemption rules and are well-equipped to help businesses meet their tax obligations. 

The highly-skilled professionals at our disposal can lead you through restructuring your enterprise under the recently modified TOSI guidelines, guaranteeing that all allowances within reach have been utilized.

Reach out to us as soon as possible for additional information about how we can provide support and guidance concerning matters about tax legislation, such as abiding by the stipulations set forth under TOSI exemptions regulations.

FAQ’s

What is the meaning of income splitting in Canada?

The act of redistributing earnings among lower-earning family members in Canada is a fiscal tactic known as income splitting aimed at lessening the tax obligation of taxpayers. This methodology leverages Canada’s incremental taxation system, subjecting higher-income earners to steeper taxes.

However, following Canada’s tax laws and regulations is essential to ensure effective income splitting.

The Canada Revenue Agency (CRA) guidelines aim to prohibit taxpayers from utilizing this technique to reduce their tax obligations unjustifiably. Those who breach regulations regarding income splitting could be subject to punishments and financial penalties, emphasizing the significance of complying with CRA’s policies while deploying the said methodology for reducing taxes.

What are the eligibility criteria for income splitting in Canada?

When examining an individual’s suitability for income splitting in Canada, there are various factors to consider. Some of these determinants include age and the particular category of pension they receive.

If a person is 65 years or older and not obtaining credits like CPP, then it is feasible to distribute their earnings from qualifying payments such as Registered Retirement Savings Plan (RRSP) and Registered Retirement Income Fund (RRIF) along with other financial sources.

However, those under age 65 are only eligible for pension splitting on specific life annuity payments or in the event of a partner passing. Understanding the rules and regulations surrounding income splitting eligibility is crucial to ensure that one takes full advantage of this tax-saving strategy while adhering to the CRA’s guidelines.

Will income splitting be allowed in 2023?

The Tax on Split Income (TOSI) in Canada has recently expanded to include individuals over 18, whereas previously, it only applied to those under 18. This expansion of the TOSI rules has significant implications for families who have used income-splitting as a tax-saving strategy for their children.

Notwithstanding, certain exemptions are present that diverge from this principle. One such exception is observed in the case of persons between ages 18 and 24 who have diligently committed at least twenty hours each week to their employment; these individuals shall be freed from TOSI’s grasp so they may enjoy income splitting without concern for added taxation burdens.

It remains paramount to keep up-to-date with current tax codes as one looks towards employing effective measures regarding income division and abiding by CRA rules.

How does income splitting work for Canadian seniors?

Income splitting is a tax-saving strategy that seniors in Canada commonly use. Amidst varied approaches such as the distribution of investment income, pension schemes, and monetary support from a significant other with whom one shares their home without legal marriage ties, older adults can reap the rewards owing to lower tax rates that apply to a said partner who earns less.

As such, they can limit their collective taxable income, leading to a decrease in overall taxes due and an increase in retirement savings potential.

However, it is essential to ensure that any income-splitting strategies used by seniors comply with Canadian tax laws and regulations to avoid penalties and fines. It is recommended that seniors consult with a tax professional to understand the most effective and compliant income-splitting strategies for their situations.

Can income splitting only be done if both spouses are 65 or older in Canada?

Within Canada, the beneficiary partner isn’t required to surpass 65 years of age for income-splitting privileges. This signified that a significant other or domesticated companion who procures fewer earnings now could gain from shared revenue with their more financially successful counterpart without regard for chronological position.

Moreover, the amount split can be adjusted annually to maximize the couple’s tax savings. Modifying the yearly divisible amount would be beneficial to capitalize on the progressive nature of the tax system and decrease the total taxes paid. However, it is crucial to acknowledge that any technique used for splitting income must adhere strictly to regulations and laws in Canada.