Tax on Split Income (TOSI) 2026: What Family Businesses Must Understand

For decades, income splitting was a legitimate planning strategy for Canadian family businesses.

Shares were issued to spouses.
Dividends were paid to adult children.
Trusts were used to distribute corporate profits.

Then came the Tax on Split Income.

If you are part of a family-owned enterprise and dividends are paid to family members, one provision matters:

Income Tax Act (ITA) s.120.4

This is the Tax on Split Income (TOSI) regime.

It is one of the most misunderstood — and most aggressively enforced — areas of personal tax law today.

CRA’s administrative guidance is outlined in Folio S1-F5-C1.

Let’s examine how it actually works.

 

What Is TOSI?

TOSI applies a penalty tax rate to certain income received by individuals from related private businesses.

If income is caught by TOSI:

It is taxed at the top marginal rate — regardless of the recipient’s income level.

That means:

• No benefit from lower tax brackets
• No advantage from basic personal amounts
• No benefit from most credits

The policy objective is clear:

Prevent artificial income splitting within families.

 

What Income Is Caught?

Under ITA s.120.4, TOSI may apply to:

• Dividends from private corporations
• Certain shareholder benefits
• Income from partnerships or trusts
• Capital gains in some cases
• Income from a related business

The key question is:

Is the income derived from a “related business”?

If yes, the next step is determining whether an exception applies.

 

What Is a “Related Business”?

A related business generally exists if:

• A related individual (such as a parent or spouse) is actively engaged in the business, or
• The business is controlled by a related individual

This captures most private family corporations.

If your spouse or parent owns or controls the corporation, it is likely a related business.

 

The Core Question: Does an Exception Apply?

TOSI does not apply if one of several exceptions is met.

The most important are:

1. Excluded Business
2. Excluded Shares
3. Reasonable Return
4. Age-Based Exceptions

Let’s examine each.

 

Excluded Business: The 20-Hour Rule

If the individual:

Is actively engaged in the business on a regular, continuous, and substantial basis

TOSI may not apply.

CRA generally interprets this as:

• At least 20 hours per week during the year, or
• 20 hours per week in any 5 prior years

This is often called the “20-hour rule.”

Documentation matters.

Time logs, payroll records, and operational involvement should be demonstrable.

 

Excluded Shares

TOSI may not apply to dividends received by an adult individual if:

• The individual owns at least 10% of votes and value
• The corporation earns less than 90% of income from services
• The corporation is not a professional corporation
• The individual is at least age 25

Professional corporations are generally excluded from this exception.

For many incorporated professionals, this exception is not available.

 

Reasonable Return

If an individual receives income that represents a “reasonable return” based on:

• Labour contributions
• Capital invested
• Risks assumed
• Prior income

TOSI may not apply.

This is a facts-and-circumstances test.

CRA Folio S1-F5-C1 outlines how reasonableness is evaluated.

Subjectivity creates audit risk.

 

Age-Based Exceptions

• Under age 18 → Almost always subject to TOSI.
• Age 18–24 → Stricter capital and labour tests apply.
• Age 65+ → Special spousal pension-like exceptions may apply.

For succession planning, age matters significantly.

 

Capital Gains and TOSI

TOSI may apply not only to dividends — but also to certain capital gains on shares of private corporations.

This is particularly relevant in intergenerational transfers.

Planning under:

• ITA s.84.1
• LCGE rules
• Intergenerational transfer provisions

Must consider TOSI interaction.

Improper structuring can convert what appears to be a capital gain into fully taxed split income.

 

Common Misunderstandings

“My spouse owns shares, so dividends are fine.”
Not necessarily.

“Adult children are safe.”
Only if they meet exceptions.

“We’ve always done it this way.”
Pre-2018 practices may now be non-compliant.

“If the corporation pays dividends equally, it’s fair.”
Fairness is not the test. The statute governs.

 

Audit Focus in 2026

CRA scrutiny remains strong in:

• Professional corporations
• Passive investment corporations
• Trust distributions
• Intergenerational transfers
• Corporations with minimal documented involvement by shareholders

Defensible documentation is essential.

 

Strategic Planning for Family-Owned Enterprises

For families building long-term businesses:

Income splitting is not dead.

It is conditional.

Proper planning may include:

• Ensuring genuine labour contributions
• Structuring share classes carefully
• Documenting active engagement
• Modeling excluded share eligibility
• Reviewing succession plans

The objective is not avoidance.

It is compliance with clarity.

 

Why This Matters for Generational Wealth

TOSI changed the income-splitting landscape.

But it did not eliminate family enterprise strategy.

It forced discipline.

Families who:

• Formalize roles
• Document contributions
• Align ownership with involvement

Can still structure efficiently.

Families who ignore the rules risk reassessment at top marginal rates.

 

Final Thoughts

The Tax on Split Income under ITA s.120.4 is one of the most significant personal tax provisions affecting family businesses.

It is detailed.

It is technical.

And it is enforced.

CRA Folio S1-F5-C1 provides interpretive guidance — but the statute controls.

For families navigating ownership, succession, and intergenerational wealth transfer, TOSI analysis must be deliberate.

Tax planning is no longer about splitting income casually.

It is about structuring intentionally.

At Shajani CPA, we advise families with precision, discipline, and foresight.

Tell us your ambitions, and we will guide you there.

This information is for discussion purposes only and should not be considered professional advice. There is no guarantee or warrant of information on this site and it should be noted that rules and laws change regularly. You should consult a professional before considering implementing or taking any action based on information on this site. Call our team for a consultation before taking any action. ©2026 Shajani CPA.

Shajani CPA is a CPA Calgary, Edmonton and Red Deer firm and provides Accountant, Bookkeeping, Tax Advice and Tax Planning service.