Estate planning: How tax on split income can affect your strategy

For many Canadian families, income splitting has long been a cornerstone of tax‑efficient estate planning. The tax on split income (TOSI) rules were originally designed to curb this practice—i.e., shifting income to family members in lower tax brackets so the family pays less tax overall. But in practice, TOSI has much broader implications, particularly for how families transfer wealth across generations and structure their estate plans. When developing or updating your estate plan, it’s important to understand where TOSI can create unexpected tax exposure—and how thoughtful planning can help keep your long‑term goals on track.

How the rules work  

The TOSI rules can apply the highest marginal tax rate to certain types of income—such as dividends from private corporations—when that income is paid to related individuals who didn’t meaningfully contribute to the business.  

Based on these rules, a person’s tax rate on certain types of income from a business or endeavour should reflect their contribution (e.g., labour, investment, or risk) to the business. Therefore, if someone receives income through share ownership, for example, that income could be taxed at the highest marginal tax rate (instead of their personal tax rate) under the TOSI rules. 

When it comes to estate planning, this matters because income earned through share ownership—such as dividends paid to family members—may not receive the tax treatment that families historically relied on. Often, spouses or adult children can only be taxed at standard marginal tax rates if they meet a specific TOSI exclusion. Otherwise, this income could be taxed at the highest marginal tax rate. 

Key areas relevant to estate planning 

Inherited property 

When someone inherits assets, determining how the income or gains are taxed depends on the age of the person receiving the assets and their relationship with the person who passed away.  

If someone under 25 years old inherits an asset from a parent, income or gains on that asset aren’t subject to TOSI, as it meets an exclusion by meeting the “inheritance criteria”. This also applies to assets inherited from anyone (not just a parent) if the recipient is under 25 and is a full-time student or eligible for the disability tax credit.  

If the recipient is 18 years or older and doesn’t meet the inheritance criteria, income or gains on inherited property aren’t automatically excluded. Instead, the recipient of the asset “inherits” the business contributions of the deceased. Whether the resulting income or gains is subject to TOSI depends on whether those contributions qualify for an exception.  

Individuals 65 or older 

Income splitting with a spouse becomes easier once a taxpayer turns 65. At that point, the taxpayer’s spouse can rely on their partner’s contributions to the business to qualify for a TOSI exclusion. Specifically, if the spouse receives an amount from a related business, the amount won’t be subject to TOSI if their spouse is 65 or older during the year, and the amount would’ve been excluded from TOSI if their spouse received it directly. 

Capital gains realized on death 

Under the TOSI rules, capital gains that arise because of a taxpayer’s death are excluded from TOSI. This ensures that taxpayers aren’t penalized for circumstances out of their control. It’s also a helpful exclusion to keep in mind when estate planning as it can simplify how assets are taxed when someone passes away. 

Other estate planning strategies  

While the rules on income splitting and passive income have limited the effectiveness of certain estate planning strategies, there are still many options available for those looking to shift assets to their children. 

Maintain QSBC status  

If your company is a qualified small business corporation (QSBC), gains incurred on the sale of those shares are generally excluded from the TOSI rules. This is even true where the shareholders didn’t make a meaningful contribution to the underlying business, which allows for planning that could give multiple family members access to the lifetime capital gains exemption. 

QSBC status for your private company is especially important if you anticipate a sale or transition soon. To be considered a QSBC, the corporation must be a Canadian-controlled private corporation (CCPC) throughout the 24 months before the sale and at least 50% of the fair market value of its assets must have been used principally in an active business in Canada. At the time of sale, this 50% test converts to an “all or substantially all” test.  “All or substantially all” is often taken to mean 90%, though there are several instances where a lower threshold was considered acceptable. 

If a corporation that would otherwise be considered a QSBC is holding a large portion of its total asset value in passive assets, and a sale is anticipated, it may be effective to transfer the passive assets (e.g., to a holding company)  so that the CCPC can achieve QSBC status by the time of sale. 

Structure share ownership transitions carefully  

In some cases, you may qualify for the “excluded shares” exception under TOSI if you’re a shareholder directly holding shares that represent at least 10% of a company’s votes and value. In these situations, you should plan to structure the transfers of shares to the next generation in a way that preserves these thresholds. This applies to both transfers that occur during your lifetime—such as under the intergeneration business transfer rules or through an estate freeze—or on death. 

Consider the intergenerational business transfer rules 

While TOSI often becomes relevant after a business is transferred and dividends start flowing to family members, there are planning strategies that can be put in place before the transfer to reduce that risk. 

The intergenerational business transfer rules allow owners to transfer a family business to the next generation and receive similar tax treatment to selling it to an unrelated third party (i.e., taxing the sale as capital gains instead of fully taxable dividends). Before these rules were enacted, it was less favourable to sell a business to a family member. 

By carefully structuring how ownership moves to the next generation, families can plan not only for a tax efficient transfer, but also for who will own shares and receive income going forward. This upfront planning can help limit ongoing TOSI exposure, rather than reacting to it after the transition is complete. 

Plan estate freezes strategically 

Estate freezes—sometimes through a family trust—can be an effective way to bring future generations into a business while still exercising a certain level of control. In the context of TOSI, estate freezes can be a way to restructure corporate ownership in a way that shifts votes and future value around so that the “excluded shares” TOSI exception might be met or to ensure that appropriate shares are in place to take advantage of the age 65+ spousal exemption. At the same time, when executing an estate freeze (and subsequent share redemption strategy) it’s important to ensure that you don’t inadvertently lose access to the excluded shares TOSI exception—for example, by reducing ownership of voting shares to below 10%.  

Prepare for post-mortem planning  

When someone passes away owning shares of a private company, it’s very common that planning must be carried out to avoid paying tax twice on the value of the shares. Common post-mortem planning strategies involve “pipeline” planning or “loss carryback” planning. TOSI considerations do need to be navigated under each of these planning techniques.
 
For example, under both pipeline and loss carryback planning, it’s possible for the original shares owned by the deceased to be eliminated through a redemption or sale to a related company, such that the beneficiaries don’t end up receiving them directly. This could cause the inherited property rules described earlier to not apply. This should be considered in the estate planning process and the post-mortem execution of such planning. 

Building your estate plan  

These estate planning strategies highlight the importance of planning early and robust record-keeping. Early, proactive tax planning helps maximize outcomes and avoid surprises. For family businesses that grow and transfer ownership over multiple generations, maintaining clear records of who contributed labour, capital, and risk becomes increasingly important for TOSI purposes.  

We can help you align your tax strategy with your long-term goals.