How to Use Income Splitting in Canada to Legally Lower Family Tax Burden

If you run a family business in Canada, chances are you’ve heard of income splitting. You may already pay a spouse a salary, issue dividends to an adult child, or look into trusts as a way to reduce your household’s tax bill. But while many business owners are aware of the concept, few explore the more advanced strategies that can lead to meaningful and lasting benefits, especially in a tax environment that has changed considerably over the past few years.

Since the introduction of the Tax on Split Income (TOSI) rules, the Canada Revenue Agency (CRA) has tightened its approach to how income can be shared within a family. Many traditional techniques no longer work as they once did, and the margin for error is narrower. That doesn’t mean the opportunity is gone, it just requires a more thoughtful and structured approach.

In this article, we’ll walk through some of the more creative and compliant income splitting options still available to family businesses in Canada.

Income Splitting in Canada: A Smarter Approach for 2025

Income splitting allows families to distribute business income among members in lower tax brackets, which can significantly reduce the overall tax burden. For family-owned businesses, especially those where more than one person contributes to operations, it presents a legitimate and effective planning opportunity.

However, the introduction of the Tax on Split Income (TOSI) rules has reshaped how this strategy can be used. These rules target income diverted to individuals who don’t actively participate in the business or haven’t invested capital. For example, if only one spouse works in the company but both receive dividends, the CRA may reclassify that income and apply a higher tax rate.

While TOSI narrowed the options, it didn’t eliminate them. Several pathways remain available—particularly for those who involve family members in meaningful roles, document contributions clearly, and structure compensation with purpose. With thoughtful planning, income splitting can still support tax efficiency within the boundaries of today’s rules.

5 CRA-Compliant Income Splitting Strategies for Families

For family businesses looking to reduce tax without running afoul of CRA scrutiny, several options remain viable. Each strategy requires structure, documentation, and a clear link between compensation and actual involvement. The following techniques demonstrate how families can still make the most of income splitting in Canada.

1. Pay Family Members a Salary That Passes the Reasonableness Test

Paying a spouse, child, or other relative for their role in the business is one of the most accessible approaches. But this only works when the amount paid aligns with the nature of the work performed. The CRA expects compensation to be comparable to what you would pay an unrelated employee in a similar role.

That means job descriptions, time logs, and performance records matter. Paying a child for bookkeeping or inventory work can be entirely valid, but only if the effort and hours match the pay. A well-maintained payroll file can be just as powerful as a tax return when it comes to demonstrating legitimacy.

2. Use Prescribed Rate Loans to Transfer Investment Income Legally

A lesser-used yet highly effective option involves loaning money to a lower-income spouse or adult child using the CRA’s prescribed interest rate. Once established, the funds can be invested by the recipient, and any income generated is taxed in their hands not the lender’s.

To qualify, the arrangement must be formal. That includes a written agreement, a fixed interest rate (based on CRA’s quarterly rate), and annual interest payments by January 30 of each year. If these steps are skipped, the income may be attributed back to the lender. When set up correctly, this strategy can shift thousands of dollars in investment income away from higher brackets.

3. Allocate Dividends with a Discretionary Family Trust

A discretionary family trust can allow business owners to allocate dividends among multiple beneficiaries, often children or spouses. This structure can support long-term tax planning while enabling flexibility in how profits are shared.

However, the TOSI rules apply here as well. Allocating dividends through a trust requires more than paperwork; it must be backed by real participation or capital involvement. The age of the beneficiary and their history with the business will also influence whether income qualifies for favourable treatment.

In some cases, trusts can also assist with succession planning. By allocating dividends or capital gains strategically, families can build wealth in the next generation while reducing exposure to higher personal tax rates.

4. Freeze Shares to Maximize the Lifetime Capital Gains Exemption

This strategy involves converting the business owner’s current shares into fixed-value shares and issuing new growth shares to family members or a trust. The goal is to cap the owner’s future tax liability while transferring future growth to others who may be in lower tax brackets.

An estate freeze can help preserve access to the Lifetime Capital Gains Exemption (LCGE), which currently allows up to $1.25 million in gains to be sheltered from tax when qualifying shares are sold. By spreading ownership across multiple family members, the exemption can be multiplied.

This approach also opens the door to broader wealth planning. Coordinating share structures with retirement goals and intergenerational transitions reflects the type of integrated planning we help many of our clients with.

5. Split Pension Income After Age 65 to Reduce Tax

For business owners nearing retirement, pension income splitting often goes unnoticed. If one spouse receives qualifying pension income, up to 50% can be reported by the other. This can lower the couple’s combined tax bill and may also help preserve access to income-tested benefits.

The types of income that qualify vary, but registered pension plans and certain annuities are often eligible. This technique doesn’t require business involvement from both spouses, making it especially useful for owners who plan to scale back while still drawing income.

Common Mistakes That Can Undermine Income Splitting Plans

Effective income splitting depends on both good planning and precise execution. Missteps, even if unintentional, can attract unwanted scrutiny from the CRA. Here are some of the more frequent errors family businesses make.

One common issue is overlooking the reasonableness test. The CRA requires that salaries or dividends paid to family members reflect the actual value of their work or investment. Payments without clear job duties, time records, or other support may be reassessed.

Another mistake involves assuming that all family members automatically qualify for exemptions under the TOSI rules. Past involvement or minor shareholdings do not guarantee favourable tax treatment. Each case must be reviewed based on the individual’s current role, hours, or contribution to the business.

Prescribed rate loans, while effective, can backfire if they’re not properly managed. Without a written agreement and consistent annual interest payments, the income may be taxed in the lender’s hands, not the borrower’s.

Trusts also require care. A structure that worked when it was first established might fall out of compliance if it isn’t reviewed regularly. Changes in legislation or in a beneficiary’s involvement can affect whether distributions are taxed appropriately.

The CRA now uses advanced technology to detect irregular patterns. Tactics that once avoided notice may now prompt questions. Staying proactive helps ensure that income splitting remains a benefit, not a liability.

Why Strategic Planning Matters for Income Splitting Success

Income splitting is not just about reducing tax in the short term. To be effective, it must be built on structure, timing, and purpose. Simply allocating income across family members without a broader plan often leads to missed opportunities—or worse, missteps that increase risk.

When applied with care, income splitting supports more than tax efficiency. It often becomes a key part of larger decisions, such as how and when to transition ownership, how to value the business fairly, and how to pass assets to the next generation in a way that preserves both family harmony and financial health.

This is where a strategic approach makes a difference. Aligning ownership, compensation, and investment with long-term business and personal goals helps avoid friction and supports continuity. For example, reorganizing shares or freezing ownership interests can influence not only tax outcomes but also how value is unlocked over time.

At Avisar, our advisory work often brings together multiple perspectives—corporate structure, estate considerations, and current tax rules. This wholistic approach ensures that income splitting isn’t handled in isolation but integrated into a plan that reflects the bigger picture.

Final Thoughts on Making Income Splitting Work for Your Family

Family businesses in Canada continue to have meaningful ways to reduce tax through income splitting, even with tighter rules in place. The opportunity hasn’t disappeared, it’s evolved. Now, success depends on thoughtful planning, accurate records, and a structure that fits both the business and the people behind it.

If it’s been a few years since you reviewed your approach, now is a good time to make sure it still meets your needs. The right plan should reflect your goals, your family’s involvement, and the latest expectations from the CRA.

If you’re a business owner navigating income splitting and long-term planning, our advisory team would be happy to explore options tailored to your structure. Book a consultation with Avisar today.

Disclaimer: Avisar Chartered Professional Accountant’s blog deals with a number of complex issues in a concise manner; it is recommended that accounting, legal or other appropriate professional advice should be sought before acting upon any of the information contained therein. Although every reasonable effort has been made to ensure the accuracy of the information contained in this post, no individual or organization involved in either the preparation or distribution of this post accepts any contractual, tortious, or any other form of liability for its contents or for any consequences arising from its use.