Income Splitting 101: What Canadians Need to Know

What is income splitting?

Income splitting (also called income sprinkling) is a tax-planning strategy, usually used by couples (spouses or common-law partners) or within a family. The basic idea of income splitting is simple: move income from one higher-income family member to a lower-income family member to lower the tax bill for the household overall.

Because Canada uses a progressive tax system—where your income is divided up into brackets and each bracket is taxed at a different rate—reducing the portion of your income taxed at higher rates can save you money. So, if a family can legally distribute the income of a higher-earning person among multiple family members, the overall tax bill for the family may be reduced.

A simple income-splitting example

Let’s look at an example. Suppose Spouse A earns $150,000 per year as a self-employed sole proprietor, and Spouse B earns $40,000 from a part-time salaried job. To legally shift income, Spouse A hires Spouse B to help with her business’s bookkeeping, website maintenance, and social media marketing, paying $30,000 per year.

For simplicity (these are fictional tax rates), let’s assume:

• Income up to $50,000 is taxed at 20%
• Income over $50,000 is taxed at 40%

Before income splitting

Spouse A: $150,000

First $50,000 × 20% = $10,000

Remaining $100,000 × 40% = $40,000

Total tax = $50,000

 

Spouse B: $40,000

$40,000 × 20% = $8,000

Total tax = $8,000

 

Combined household tax bill without income splitting:

$50,000 + $8,000 = $58,000

 

After income splitting

Assume $30,000 of income could legally be shifted from Spouse A to Spouse B.

Spouse A: $120,000 ($150,000 less $30,000)

First $50,000 × 20% = $10,000

Remaining $70,000 × 40% = $28,000

Total tax = $38,000

 

Spouse B: $70,000 ($40,000 plus $30,000)

First $50,000 × 20% = $10,000

Remaining $20,000 × 40% = $8,000

Total tax = $18,000

Combined household tax bill with income splitting:

$38,000 + $18,000 = $56,000

Potential tax savings: $2,000

Of course, the situation is a little more complicated with real tax rates. And while this scenario seems like an easy way to save money on taxes, options for income splitting are very limited, and the Canada Revenue Agency (CRA) has several rules designed to prevent people from simply moving income around on paper to reduce taxes.

Why do people consider income splitting?

The main goal is straightforward: reducing the family’s total tax bill.

Other potential benefits may include:

• Reduced exposure to higher marginal tax brackets
• Increased access to income-tested credits and benefits
• Better retirement income planning
• More efficient use of family wealth

The attribution rules for income splitting

One of the biggest obstacles to income splitting is Canada’s attribution rules. There are some exceptions, but these rules generally prevent a taxpayer from transferring or gifting property to a spouse or minor child solely to shift investment income.

For example, suppose you transfer $100,000 to your spouse and they invest it in stocks that generate $5,000 in dividends each year. Without attribution rules, those dividends would be taxed in your spouse’s hands, potentially at a much lower tax rate.

However, the attribution rules generally require that investment income be attributed back to the original contributor. In other words, the CRA treats the income as though you earned it yourself. The same concept often applies when funds are transferred to minor children.

What do the attribution rules include?

Canada’s attribution rules generally cover all income and growth generated from transferred property, including:

• Dividends
• Interest
• Rental income
• Capital gains (investment growth, except if property is transferred to a minor-aged child), but after separation, divorce, or death of a spouse, attribution back to the contributor stops.

When income splitting is still permitted

Although many methods of income splitting have attribution rules, several income-splitting opportunities remain available for families.

Pension income splitting

Pension income splitting is one of the most common and straightforward ways to split income.

Eligible Canadian residents can allocate up to 50% of eligible pension income to a spouse or common-law partner when filing their tax return.

This does not involve physically transferring money. Instead, it is an election made on the spouses’ tax returns.

Potential benefits include:

• Lower overall household taxes
• Reduced Old Age Security (OAS) clawback exposure
• Improved access to income-tested benefits and credits

Spousal RRSP

A spousal RRSP allows a higher-income spouse to contribute to an RRSP owned by their spouse or common-law partner.

Here’s how spousal RRSP contributions affect taxes: The contributor receives the RRSP deduction, while the spouse generally reports future withdrawals as income. However, if the lower-income spouse withdraws the money too soon (before 3 calendar years), it can be attributed back to the contributor.

Prescribed rate loans

A prescribed rate loan is a legal income-splitting strategy. A higher-income spouse lends funds to a lower-income spouse to invest and generate investment income. The higher-earning spouse charges the CRA’s prescribed interest rate.

If the loan is structured properly and all required interest payments are made on time (usually once a year), future investment income can be taxed in the borrower’s hands rather than being attributed back to the lender. 

The CRA updates the prescribed interest rates quarterly. For a new prescribed rate loan, use the rate in effect during the quarter when you lend the money. The interest rate on the loan remains the same even if the CRA changes prescribed rates in the future.

This strategy isn’t suitable or effective for everyone. If you’re considering it, you may want to first consult a financial planner about your specific situation.

Paying family members a salary

Business owners may be able to employ family members in their business.

If a spouse, child, or other family member performs legitimate work and receives reasonable compensation for that work, the salary may be deductible to the business and taxable to the recipient.

The CRA rules are:

• The work must actually be performed.
• The compensation must be reasonable.
• Proper payroll records must be maintained.

“Paying a teenager $50,000 a year to occasionally answer the phone probably won’t hold up to scrutiny,” cautions Santos. “But paying a family member a market-rate wage for genuine work that helps your business may be perfectly acceptable.”

What is Tax on Split Income (TOSI)?

One of the most important concepts for business owners is the Tax on Split Income (TOSI) rules. TOSI is designed to prevent certain types of income splitting between family members, involving private corporations.

Many forms of income received from a related private corporation may be subject to TOSI rules. When TOSI applies, the income distributed to family members is generally taxed at the highest marginal tax rate, eliminating most or all the intended tax benefit.

How TOSI works

TOSI can apply to various types of income, including:

• Dividends from private corporations
• Certain shareholder benefits
• Some partnership income
• Certain trust allocations
• Other income derived from a related business

Key TOSI exceptions

There are several important exceptions to TOSI rules.

• Excluded businesses: Income may be exempt from TOSI if the recipient is actively engaged in the business on a regular, continuous, and substantial basis.
• Excluded shares: This exception typically applies only when specific ownership requirements are met and may not be available for professional corporations or certain service-based businesses.
• Reasonable return: Income may avoid TOSI if it represents a reasonable return based on the individual’s contributions to the business.
• Other relevant factors: Labour, capital invested, risks assumed, and being the spouse of a business owner who is over age 65 can be factors in allowing income splitting.

Income splitting remains a valuable tax-planning concept, but it is far more restricted than it once was.

“Understanding the rules of income splitting can help you identify tax-saving opportunities, avoid costly mistakes, and ensure you’re paying no more tax than required under Canadian tax law,” says Santos. “If you have questions about income splitting, it’s a good idea to check with a tax professional.”