If a business is taxed primarily in the hands of one family member while another family member has little or no income, there is often a meaningful opportunity to reduce the family’s overall tax bill by shifting some income to the lower-income spouse or family member — provided this is done in a way that reflects genuine economic reality and complies with the rules governing income splitting.
The foundational principle for income splitting with family members in a sole proprietorship or small business is "reasonableness." If a family member is paid for work performed in the business, the amount paid needs to be reasonable in relation to the work actually performed — comparable to what would be paid to an arm‧s-length person for the same work. Paying a family member an amount disproportionate to the work performed, simply to shift income to a lower tax bracket, is the kind of arrangement the CRA scrutinizes.
Paying a Spouse or Family Member for Work Performed
If a spouse, adult child, or other family member genuinely performs work for the business — bookkeeping, administrative support, marketing, or other roles — paying them a reasonable salary or wage for that work is a legitimate business expense, deductible to the business, and taxable income to the family member (at their own marginal rate, which may be lower than the business owner’s).
The key word is "reasonable" — both in terms of the amount paid relative to the work performed, and in terms of the work actually being performed. Documentation matters here: records of hours worked, the nature of the work, and how the compensation compares to what an arm’s-length person would be paid for similar work, support the arrangement if it is ever reviewed.
The Tax on Split Income (TOSI) Rules
For income paid to family members that is not clearly tied to reasonable compensation for labour — particularly relevant for dividends from a private corporation, but with implications that intersect with broader income-splitting planning — the Tax on Split Income (TOSI) rules can apply, taxing certain income received by family members at the highest marginal tax rate, effectively eliminating the income-splitting benefit for income that falls within these rules.
TOSI includes exceptions — for example, for family members who are meaningfully and actively engaged in the business on a regular, continuous, and substantial basis, or for adults aged 25 and older who meet certain ownership or "excluded shares" criteria. These exceptions are detailed and depend on specific facts (hours worked, ownership percentages, the nature of the business), making this an area where the specific structure of a family business benefits from a careful review against the TOSI rules, rather than assuming a general "pay family members" strategy will automatically work as intended.
Spousal RRSP Contributions
Separate from paying a family member for work, a higher-earning spouse can contribute to a spousal RRSP — an RRSP in the lower-earning spouse’s name, with the contribution based on the higher earner’s RRSP room. This does not require the lower-earning spouse to perform any work in the business; it is a separate mechanism for building retirement savings in the lower-earning spouse’s name, which can be useful for balancing retirement income (and therefore retirement-year tax rates) between spouses over the long term.
Income Splitting Through Family Trusts
For some business structures, particularly incorporated businesses, family trusts have historically been used as part of income-splitting strategies — allowing income to be allocated among family members who are beneficiaries of the trust. However, the TOSI rules discussed above significantly limit the effectiveness of this approach for many situations, and family trust structures involve their own complexity and compliance requirements (including the 21-year deemed disposition rule and ongoing trust tax filings). This is a more advanced strategy that, where still relevant, requires specialized legal and tax advice specific to the business structure.
What Does Not Work
| Approach | Why It Is Problematic |
|---|---|
| Paying a family member a salary disproportionate to work performed | Fails the "reasonableness" test; the excess may be denied as a deduction and/or attributed back to the original earner |
| Paying a family member who performs no work at all | Not a legitimate business expense; this is not income splitting but simply incorrect reporting |
| Informal "loans" of income to family members without genuine work or investment | Income attribution rules generally attribute the income back to the original earner regardless of where the funds end up |
What Often Does Work, With Proper Documentation
| Approach | Key Requirement |
|---|---|
| Reasonable salary/wages for genuine work performed by a family member | Documented hours, role, and compensation comparable to arm’s-length rates |
| Spousal RRSP contributions | Based on the contributing spouse’s available RRSP room; straightforward and well-established |
| Family member as a genuine, actively-engaged business partner or shareholder (subject to TOSI exceptions) | Meaningful, regular, continuous, substantial involvement; meets specific TOSI exception criteria |
Why This Matters Beyond the Current Year
Income-splitting arrangements that are reviewed and found not to meet the reasonableness standard can result in reassessments — not just for the current year, but potentially for multiple past years if the arrangement has been ongoing, along with associated interest and potentially penalties. This makes it particularly important to establish income-splitting arrangements on a sound footing from the outset, with documentation that supports the arrangement on an ongoing basis, rather than treating it as a one-time setup that does not need revisiting.
If you currently pay a family member through your business, or are considering doing so as part of reducing your family’s overall tax bill, the central question is whether the arrangement reflects genuine work performed at a reasonable rate — and whether documentation exists to support this if reviewed. For arrangements involving dividends or more complex structures, the TOSI rules add another layer that benefits from a review specific to your business’s ownership structure and the family members’ actual involvement.
The Self-Employed Tax Deductions Checklist
Home office deductions, vehicle expenses, income splitting, and other ways sole proprietors and small business owners can legally reduce their tax bill.
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