Robert McKercher

I study Canada's 2018 expansion of the Tax on Split Income rules, which raised the marginal tax rate applied to dividends received by certain spouses of private-business owners and thereby eliminated the tax advantage from a well-known tax-planning strategy. Using linked personal and corporate administrative tax records, I compare families exposed to the reform with those likely exempt and exploit variation in their pre-reform tax incentives and financial exposure. Dividends reported by exposed spouses decline sharply after the reform, while dividends and employment income reported by business owners increase. Family taxable income consequently remains unchanged on average and across family-income quartiles. A $X,XXX increase in the additional tax a family would owe under TOSI reduces spouse dividends by approximately X%, with similar proportional responses throughout the income distribution. The magnitude of the response varies with the additional tax a family would owe under TOSI. Families facing larger tax increases reduce spouse dividends by more. For all but the most exposed families, this income is reallocated to the owner and family taxable income remains unchanged. Among the most exposed families, the reallocation is incomplete and family taxable income declines. I find no corresponding changes in ownership, employment, corporate assets, or retained earnings. These findings show that closing an income-splitting channel primarily changes who reports business income, but begins to reduce the family tax base when the financial stakes become sufficiently large.