INCOME SPLITTING through a Professional Corporation

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Contact our law firm for your incorporation legal work at 403-400-4092 / 905-616-8864 or Chris@NeufeldLegal.com

Income splitting, subject to very strict constraints, can be achieved through a professional corporation to reduce a family's total tax liability by redistributing business income from a high-income earner, who would be taxed at the highest marginal rate (often over 50%), to a lower-income family member, such as a spouse or adult child. The professional corporation, which is a separate legal entity, creates a layer between the business earnings and the family members' personal income. This separation allows the professional to direct corporate profits toward family members in lower tax brackets. This is achieved by having family members hold non-professional shares of the professional corporation, often via a family trust, or by receiving salaries for services rendered to the corporation, thereby allowing the family to take advantage of multiple low-rate tax brackets and personal tax credits.

Income splitting through a professional corporation generally utilizes two primary mechanisms: reasonable salaries and dividend distributions. The first, paying a salary, is used when a spouse or family member provides legitimate services to the professional practice, such as administrative support, bookkeeping, or practice management. The professional corporation is permitted to deduct this salary as an expense, which reduces the corporation's taxable income. The family member then pays tax on the salary at their own, presumably lower, personal marginal rate. The second mechanism, dividend sprinkling, historically involved having non-voting shares of the professional corporation held by family members or a family trust. Corporate profits would then be distributed as dividends to these lower-income family shareholders, using their lower tax rates to efficiently extract funds from the corporation.

The ease and effectiveness of dividend sprinkling were significantly curtailed by the expanded Tax on Split Income (TOSI) rules introduced in 2018 by the Canada Revenue Agency. TOSI targets income splitting arrangements where the recipient family member does not genuinely contribute to the business. Under these rules, dividends or other non-salary distributions paid to a "specified individual" (such as a spouse or child who is not actively involved in the practice) are subject to tax at the highest federal marginal rate, effectively eliminating the tax benefit. This stringent regulation ensures that the mere act of owning shares is no longer enough to benefit from income splitting, shifting the focus back to active involvement and reasonable compensation.

Despite the TOSI restrictions, the professional corporation remains the vehicle for viable income splitting, provided the strategy meets one of the statutory exclusions. The most common exclusion applies when the family member is actively engaged in the business, which typically means working an average of at least 20 hours per week during the year or meeting an "Excluded Share" test (which is rare for professional practices). A second, crucial exclusion allows owners aged 65 or older to pay dividends to their spouse without triggering the TOSI rules, providing a valuable planning tool for retirement. Thus, while the professional corporation still enables income splitting, success now hinges on meticulous compliance, clear documentation of family member involvement, or careful planning around specific age milestones.

At Neufeld Legal, we have the experience and insight to assist you in structuring your professional practice as a Professional Corporation. Contact our law firm to incorporate a professional corporation or address legal matters pertaining to your professional corporation at 403-400-4092 [Alberta], 905-616-8864 [Ontario] or via email at Chris@NeufeldLegal.com.