Family Trust Income Splitting for Lawyers in Canada
Lawyer Insights | SG Wealth Management
Navigate complex tax rules and protect your wealth with strategic trust planning.
Understanding the Tax on Split Income (TOSI) Rules
The Tax on Split Income (TOSI) rules were introduced to curtail the benefits of income splitting with family members.
Under TOSI, split income, such as dividends received from a private corporation, is taxed at the highest marginal tax rate in the recipient's hands unless a specific exception applies. For lawyers, navigating these exceptions is critical.
The "excluded business" exception applies if the family member is actively engaged in the business on a regular, continuous, and substantial basis (generally defined as working at least 20 hours per week during the year or any five prior years). If your spouse or adult child works in your law firm in an administrative or managerial capacity meeting this threshold, dividends paid to them may be exempt from TOSI. The "excluded shares" exception, which allows for income splitting if a beneficiary owns at least 10% of the voting rights and value of the corporation, explicitly does not apply to professional corporations.
Therefore, lawyers cannot rely on this exception to split income with family members who are not actively involved in the practice. If no other exception applies, the "reasonableness test" may be considered. This test evaluates whether the distribution is reasonable based on the beneficiary's contributions to the business, including labor, capital, and risks assumed.
However, relying on the reasonableness test is subjective and carries a higher risk of scrutiny from the Canada Revenue Agency (CRA).
Splitting Capital Gains and Multiplying the LCGE
While TOSI has restricted dividend income splitting, family trusts remain highly effective for splitting capital gains and multiplying the Lifetime Capital Gains Exemption (LCGE).
If you eventually sell your law practice, the shares may qualify as Qualified Small Business Corporation (QSBC) shares. When a family trust holds the shares of your professional corporation, any capital gain realized on the sale can be allocated among the trust's beneficiaries.
Each beneficiary can then claim their own LCGE, which can shelter over $1 million in capital gains per person (as of 2024). This strategy can result in substantial tax savings, potentially eliminating the tax liability on the sale of your practice entirely. To ensure your professional corporation maintains its QSBC status, it must meet specific asset tests.
If your corporation accumulates excess cash or passive investments, it may lose this status. A family trust can facilitate the moving cash to a holding company, ensuring your operating company remains eligible for the LCGE.
Privacy, Asset Protection, and Control
Beyond tax planning, family trusts offer significant non-tax benefits. Trusts are created by written agreements and generally do not have to be registered publicly, providing a layer of privacy for your financial affairs. Asset protection is another key advantage.
Because the trustee holds legal title to the trust property and the beneficiaries only have a beneficial interest, the assets within the trust may be protected from the personal creditors of the beneficiaries. This can be particularly valuable for lawyers who face creditor protection through life insurance. Furthermore, a discretionary family trust allows you to maintain control over how and when assets are distributed to your family members.
As the trustee (or one of the trustees), you can decide which beneficiaries receive income or capital, providing flexibility to adapt to changing family circumstances.
What is the 5 year rule for trusts?
A Five-Year Trust, also known as a "Legacy Trust" or "Medicaid Asset Protection Trust" in some jurisdictions, is often established to protect assets from being spent down on long-term care.
The assets placed in such a trust typically become exempt from certain asset-testing requirements after a 5-year look-back period. While this specific rule is more common in US Medicaid planning, Canadian lawyers should be aware of the 21-year deemed disposition rule for Canadian trusts, which requires trusts to pay tax on accrued capital gains every 21 years.
Can my wife get half of my trust?
If a trust is considered 'nuptial,' a court can include it as part of the matrimonial pot to be divided between spouses upon divorce.
While there is no strict legal definition of a nuptial trust, a court is likely to determine it is 'nuptial' if the trust settlement is connected to the marriage and the spouses are beneficiaries. Proper structuring and the use of domestic contracts (such as a marriage contract) are essential to protecting assets in a family trust.
What is a split income trust?
A split interest income trust typically refers to a charitable trust that provides an income tax deduction. When funded, it provides income to you for life (or to your children) with the remainder going to a designated charity upon the death of the last-named beneficiary.
This is distinct from a standard discretionary family trust used for income splitting among family members. Related reading: estate planning for incorporated lawyers.
Frequently Asked Questions
For lawyers incorporating as a professional corporation, managing the tax burden on high income is a constant challenge.
A discretionary family trust can serve as a sophisticated legal means for income splitting, allowing you to distribute income among beneficiaries who may be in lower tax brackets, thereby reducing your family's overall tax burden. By holding the shares of your professional corporation within a family trust, dividends can be paid to the trust and then allocated to family members.
However, recent legislative changes have significantly restricted these strategies, making it essential to understand the current landscape of family trust income splitting for lawyers in Canada.
What is the main takeaway of family trust income splitting for lawyers in canada? The decisions outlined above compound across tax, investment, and risk dimensions, so they should be reviewed as one integrated plan.
Who should consider this strategy? Canadian professionals whose corporate structure or career stage matches the scenarios above will benefit most from a tailored review.
How often should I revisit this plan? Most professionals benefit from an annual review, plus a deeper update whenever income, structure, or family circumstances change.
Where do I get tailored advice? Book a consultation with SG Wealth Management to translate these concepts into a documented plan.
Build a Coordinated Strategy
SG Wealth Management provides financial planning for incorporated lawyers.
Our team structures estate planning for incorporated lawyers that withstand CRA scrutiny and preserve legitimate splitting opportunities.
