Income Splitting for Sole Proprietors in Canada

Income splitting sounds like one of those too-good-to-be-true tax hacks: pay a family member, spread the income around, and shrink your tax bill. For Canadian sole proprietors, income splitting is a real thing—but only if you play by Canada Revenue Agency (CRA) rules.

“Income splitting isn't about gaming the system,” says Shilpa Banda, a tax expert at TurboTax Canada. “It's about structuring your business intelligently and documenting everything, so it holds up under CRA scrutiny.”

Here's how income splitting works for sole proprietors, where the CRA draws the line, and how to decide whether it makes sense for your business.

What is income splitting in Canada?

In a nutshell, income splitting means shifting some income to a family member who's taxed at a lower rate. For Canadian sole proprietors, this typically involves hiring a spouse or child to work in the business, paying them a reasonable wage, and deducting that pay as a business expense on your personal tax return.

Why does this matter? Because sole proprietor taxes are personal taxes, and every dollar of profit is taxed at your marginal tax rate. “If all your income lands on your return, it can push you into higher tax brackets fast,” says Banda. “Income splitting can ease that pressure and keep more wealth in the family.”

Let's look at an example, using 2025 federal tax rates only and ignoring any tax credits. (Note: The federal tax rate for the lowest tax bracket was lowered from 15% to 14% halfway through 2025, so the effective tax rate for the year is 14.5%.)

Scenario 1: No income splitting Spouse A's income: $120,000 Spouse B's income: $0 Spouse A tax (on $120,000): First $57,375 × 14.5% = $8,319 Next $57,375 × 20.5% = $11,762 Last $5,250 × 26% = $1,365 Total ≈ $21,446 Spouse B tax (on $0): $0 Total household federal tax ≈ $21,446

Scenario 2: Income transfer of $20,000 from spouse A to spouse B Spouse A's income: $100,000 Spouse B's income: $20,000 Spouse A tax (on $100,000): First $57,375 × 14.5% = $8,319 Remaining $42,625 × 20.5% = $8,738 Total ≈ $17,057 Federal tax for spouse B (on $20,000): $20,000 × 14.5% = $2,900 Total household federal tax: $19,957 (savings of ≈ $1,488)

The benefits of income splitting can also extend into the future. Paying your kid a legitimate salary helps them start building Registered Retirement Savings Plan (RRSP) contribution room early. Once kids turn 18, they can also start contributing to the Canada Pension Plan (CPP), which can provide income decades down the road.

How does income splitting work in Canada?

For sole proprietors, income splitting comes down to one main rule with two important words: you can pay a related person (typically a spouse or child) for legitimate work they actually do for your business, and the pay must be reasonable. At tax time, you report your business and professional income and expenses on Form T2125, Statement of Business or Professional Activities. Eligible business expenses lower your taxable business income.

The CRA looks at whether the work is necessary for your business and whether the pay makes sense for the position. Paying your spouse for bookkeeping? Possibly okay. Paying your teenager executive-level wages for “vibes”? Not so much.

You also need to treat family members like any other employee when it comes to payroll, including tracking hours, making required deductions, remitting amounts to the CRA, and issuing T4 slips.

“The CRA expects family members to be treated the same way as any other employee,” says Banda. “That means the work must be necessary, the pay must be reasonable, and your records need to support it.”

Who is eligible for income splitting in Canada?

Short answer: Family members who help run your business. Under CRA rules, a related person is someone connected to you by blood relationship, marriage, common-law partnership, or adoption.

That said, income splitting only works if the CRA agrees that the business relationship exists. If a family member is doing real, necessary work you would otherwise have to pay someone else for, income splitting may be an option. Here are some examples.

Income splitting with your spouse or common-law partner

If your partner helps keep the business running (think bookkeeping, invoicing, scheduling, customer emails, admin, etc.), paying them a reasonable wage may qualify. This is one of the most common income splitting set-ups for sole proprietors.

“A lot of business owners don't realize how much their partner already contributes,” says Banda. “If the work is real, it's often worth formalizing the business relationship.”

Income splitting with your children

Children can be paid to work in the business, as long as the job fits their age, skills, and experience. For instance, younger kids might help with simple organizing or cleaning. Older kids, especially those who've reached the age of majority, might take on trickier tasks, such as admin, marketing, customer support, or demystifying the latest newfangled technology that baffles the grown-ups. Note that the minimum age to work varies by province and territory and type of work or workplace. Check the requirements where you live.

There are a few hard rules. You need to compensate your child. The work must support the business (sorry, no folding laundry and calling it “operations”). And the pay should line up with what you'd pay anyone else to do the same job.

Here's an example of suspicious splitting: Chris runs a fitness and personal training business as a sole proprietor. He pays his teenage daughter a full salary as a “marketing assistant,” but the job mostly amounts to a few Instagram posts and occasionally snapping behind-the-scenes photos. There's no schedule, no tracked hours, and no clear list of responsibilities—yet the pay is high. This may raise a few eyebrows at the CRA.

Income splitting with other relatives

Income splitting may also apply when a family member helps behind the scenes with tasks like record-keeping, social media, or customer follow-ups—roles the business genuinely needs. “If you can clearly explain what someone does and why the business needs it, you're usually on the right track,” says Banda.

CRA income splitting rules to be aware of

This is where income splitting gets its reputation for being tricky. Most of that comes down to one set of rules: Tax on Split Income (TOSI).

What is Tax on Split Income (TOSI)?

TOSI is a set of CRA rules designed to prevent people from shifting income to family members who didn't actually earn it. When TOSI applies, that income can be taxed at the highest marginal rate, which generally cancels out the benefit entirely.

“TOSI isn't about punishing family businesses,” says Banda. “It's about making sure income follows the work.”

The important thing for sole proprietors to know is that TOSI targets dividends or any kind of distribution paid from incorporated businesses, also called corporations. Unlike a sole proprietorship, a corporation is a legal entity separate from its owner(s)—for example, it can enter into contracts, own assets, and carry debts. Corporations can pay employees a salary or a dividend. Since sole proprietors only pay salaries and TOSI explicitly does not apply to salaries, TOSI usually isn't a concern.

What tends to catch the CRA's attention

The CRA isn't against family members helping out with a business, but a few things tend to raise red flags:

• The job is fuzzy. If you can't explain what someone does, that's a problem.
• The pay is out of whack. This usually means paying substantially above market rates.
• The paperwork is thin or non-existent. No tracked hours, no defined job duties, irregular payments, no contracts, or skipped payroll steps make income splitting harder to defend.
• It looks like tax avoidance. If the role wouldn't exist without the tax benefit, the CRA may push back.

“When income splitting feels more like a tax move than a business decision, that's when it starts to unravel,” says Banda.

What about TOSI exemptions?

You might hear about TOSI exemptions for young adults working 20-plus hours a week, adults who own part of a corporation, or business owners over 65. Those rules mostly apply to incorporated businesses, not sole proprietorships.

For most sole proprietors, the playbook is simpler: pay fairly, document the work, and run payroll properly.

Alternatives to paying family members

In some cases, contributing to a spousal RRSP, reinvesting in the business, or planning for pension income splitting may make more sense than adding a family member to the payroll. Consider speaking to a financial advisor about your family's situation.

When to get tax advice

When income splitting is done wrong, the risks are real: denied deductions, reassessments, interest, and penalties that wipe out any tax savings. To avoid headaches, it's smart to talk to a tax expert or an accountant if:

• You're unsure whether a family member's role or pay would be considered reasonable by the CRA.
• Your business income has grown significantly year-over-year.
• You're paying multiple family members.
• You're mixing salaries with other tax strategies.
• You want reassurance that everything will hold up if the CRA asks questions.

“Getting advice early is usually cheaper—and less stressful—than fixing things after the fact,” says Banda.

Bringing it all together

For Canadian sole proprietors, income splitting is a legitimate tax strategy when it's built on real work, reasonable pay, and solid records. When those pieces are in place, income splitting can help reduce your overall tax bill while keeping you on the right side of CRA rules.

Filing taxes accurately and on time is important for your business. TurboTax is here to help. With TurboTax Business, you can file a return yourself, get expert help when you need it, or hire us to do it for you.

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