Tax on Split Income (TOSI) - Splitting income with your spouse in 2020
Updated: Nov 4, 2020
In this article I discuss splitting income between two spouses who own a corporation. We abbreviate the term Tax on Split Income as "TOSI". TOSI is a relatively new rule that aims to reduce or eliminate the tax benefits a couple can use by splitting income between each spouse. This is often been referred to "income sprinkling".
In the past, a spouse who was not active in the business and generally was in a lower tax bracket would receive dividends from a family owned corporation in order to split income more evenly and reduce the total combined income of the couple.
How does income sprinkling work?
The easiest way to explain income sprinkling is with the use of an example. In this example, I will discuss an Alberta couple who owns a corporation called Dunder Mifflin Ltd.
In the first scenario, the couple doesn't use income sprinkling. Instead, one spouse draws a management salary of $100,000 and ineligible dividends of $100,000 from the corporation. The other spouse doesn't draw any income from Dunder Mifflin Ltd. and only earns enough income to use up their basic personal tax credits and pay $0 in tax.
The spouse earning an income from Dunder Mifflin Ltd. had to pay total tax of $59,574 in the year. The other spouse didn't pay any tax. The total combined tax the couple paid was $59,574.
In the second scenario, the Spouse # 1 takes $100,000 in dividends, and Spouse # 2 takes a $100,000 management fee.
This time, their combined total tax was $43,261. This is $16,313 less tax paid than without income sprinkling!
The reason the couple is able to pay so much less tax is that they are taking advantage of the tax bracket system. Income sprinkling was a significant tax advantage business owners, doctors, lawyers, and other professionals could make use of up until the 2018 tax year. Unfortunately, these rules have changed, and it is much more difficult to reduce total tax paid by splitting income between two spouses. However, it is still possible. I will be discussing the new TOSI rules and the limitations to these rules next.
NOTE: Similar to the TOSI rules, the "kiddie tax " was introduced back in 2000. This was to address shareholders who were taking advantage of their children's low income and low tax brackets to reduce their total tax bill.
What happens if TOSI applies?
First, I want to discuss what happens if the TOSI rules apply. Generally speaking, you DO NOT want TOSI to apply. If it does apply, you will be taxed at the highest marginal rates, which is 33% federally plus provincial tax. This would result in you paying much higher taxes!
When can you split income?
There are still instances where two spouses can take income from the business without TOSI applying. In order to do so, they both have to be actively involved in the business.
The spouse worked an average of 20 hours per week or more during the current tax year.
The spouse worked on a regular, continuous and substantial basis for 5 years or more in prior tax years. The 5 years do not have to be consecutive. The phase "regular, continuous and substantial basis" generally means the individual worked at least 20 hours on average per week.
How can you split income with your spouse?
You must ensure your spouse is actively working in the business for at least 20 hours per week throughout the year. This doesn't mean you can simply have them on payroll for 20 hours per week. They must be participating in the day-to-day business activities.
Have them help out in whatever way they can. Many business owners have a spouse take care of the bookkeeping, marketing, or complete administrative work. Play on their strengths! They can likely contribute in a way that is very impactful to your business.
TOSI for Young Adults
In this article I discuss how TOSI affects spouses. However, these rules also apply to other family members. The rules for individuals aged 24 and under are very strict. I don't necessarily agree with these principles as they negatively impact young adults. However, the reason for these rules is to prevent parents from income sprinkling with their adult children, which the Kiddie Tax does not cover.
If you have questions about TOSI or are worried that TOSI could apply to you, please contact us.