Introduction

Family trusts were once the go-to income-splitting vehicle for incorporated professionals and business owners. Before 2018, a discretionary family trust holding shares of a private corporation could receive dividends and distribute them to low-income family members — shifting income from a high-rate taxpayer to lower-rate family members and reducing the household's overall tax bill.

The tax on split income (TOSI) rules introduced in 2018 significantly changed this picture. TOSI imposes the highest marginal rate on income received from a private corporation by family members who do not meet specific exceptions — effectively eliminating the tax benefit of splitting income with most family members through a trust.

This article explains where family trusts still provide value — and where the analysis has materially changed since 2018.

What Is a Discretionary Family Trust?

A discretionary family trust is a legal arrangement in which a trustee holds shares of a corporation for the benefit of a class of beneficiaries — typically the business owner's spouse and children, and potentially the business owner themselves. The trustee has discretion to allocate income and capital among the beneficiaries in any proportion each year.

This discretion is the mechanism through which income splitting historically occurred: dividends from the corporation could be allocated to the beneficiary in the lowest tax bracket in a given year.

Post-TOSI: When Trusts Still Work

The TOSI rules impose the highest marginal rate on split income from a trust unless an exception applies. The relevant exceptions for trust income include:

The excluded business exception: If the income recipient was actively engaged in the business on a regular, continuous, and substantial basis in the year (or in any five prior years), TOSI does not apply. A spouse who works meaningfully in the business — bookkeeping, administration, clinical work, office management — may meet this threshold, and income distributed to them through the trust is not subject to TOSI.

The excluded shares exception: Under the excluded shares rules, certain dividends from a corporation are not subject to TOSI if the shares are not "excluded shares" as defined in the Act. The excluded shares exception is complex and requires the shares held by the trust to satisfy specific conditions related to non-group participation. For many professional corporations, excluded shares treatment is difficult to achieve.

The over-25 reasonableness exception: For adult beneficiaries over 25 years of age, TOSI does not apply to income that is reasonable having regard to the labour contribution or capital contributions made by the recipient. An adult child who genuinely works in the business may receive reasonable compensation through the trust without TOSI.

The over-65 exception: Individuals over 65 are largely exempt from TOSI, making trusts more useful for distributions to elderly parents or in retirement planning for the business owner themselves.

Where Trusts Retain Value Post-TOSI

Capital gains multiplied through the trust: When a corporation is sold and the capital gains are distributed through a family trust, each beneficiary may be able to claim their own Lifetime Capital Gains Exemption on the distributed capital gain. At the current LCGE limit of approximately $1.25 million, distributing a capital gain to four beneficiaries could shelter up to $5 million from tax. This LCGE multiplication benefit is one of the most significant remaining advantages of the family trust structure.

Estate planning: A family trust can hold shares that grow in value over time, with the growth accumulating for the benefit of the next generation outside the estate of the business owner. This avoids probate fees on those assets and simplifies the transfer of the business interest on death.

Flexibility in income allocation: In years where an adult family member has low income and meets one of the TOSI exceptions, the discretionary nature of the trust allows income to be directed to the most tax-efficient beneficiary.

When Trusts No Longer Make Sense

For incorporated professionals with young children, or whose adult children are not involved in the business, the income-splitting benefit that once justified the administrative cost of a family trust has largely evaporated post-TOSI.

The ongoing compliance costs — annual trust returns (T3), professional fees to maintain the trust structure, and CRA scrutiny of trust distributions — may outweigh the remaining benefits for practices that are not planning a sale within the foreseeable future.

When to Speak With a CPA

A family trust that was established before 2018 should be reviewed in light of the current TOSI rules. In some cases, the trust retains significant value. In others, it has become a compliance cost with limited benefit. The analysis is specific to the business owner's income level, the beneficiaries' circumstances, and the likelihood and timing of a business sale.

Rotaru CPA helps incorporated professionals review existing family trust structures and determine whether they continue to serve their intended purpose. Book a consultation to review your trust structure.