Tax on Split Income
You may remember the good old days when you could split dividends paid by your private corporation with your minor child. High income earners with family businesses paid a lower overall tax bill since the minor child had a much lower effective tax rate. This was all legal until 2000, when the Government of Canada ended the party by adding section 120.4 to the Income Tax Act.
Better known as the "kiddie tax", if your corporation pays a dividend to a minor under the age of 18 (like your son or daughter), the minor pays tax on the dividend income at the highest marginal tax rate. That's an expensive tax bill.
In 2018, the federal government expanded the "kiddie tax" to adults. This new rule is often referred to as "TOSI".
For those of you who paid expensive fees to your accountants and lawyers hoping to split income and pay a lower overall tax bill, don't worry. There are exclusions to TOSI. Hopefully, your situation falls into one of the following two common scenarios:
Your son, daughter, spouse or other related persons worked at least an average of 20 hours per week for the company either in the current tax year or in any prior 5 consecutive years, or
Your son, daughter, spouse or other related persons is at least 25 years old, owns at least 10% of the voting shares of the corporation, and the corporation derives at least 10% of its revenue from the sale of products.
A common scenario we often see in the field is a couple who owns a company 50/50, but only one spouse is actively engaged in running the business. Assuming the business has significant product revenue, since the inactive spouse owns at least 10% of the voting shares, TOSI would not apply. Therefore, you can still split income and pay an overall lower tax bill.
If the same couple owned a company that derived all of its revenue from rendering services, such as a doctor, accounting or marketing practice, TOSI would generally apply. The inactive spouse would be taxed at the highest marginal tax rate.
There are much more complex scenarios where TOSI may or may not apply which are beyond the scope of this article. If you believe TOSI may impact you, please contact a CPA to help you assess your specific scenario.