Robert McKercher

I examine how business-owning families respond when tax rules restrict dividend-based income splitting. Using linked personal, payroll, and corporate tax records from the Canadian Employer–Employee Dynamics Database, I study Canada’s 2018 expansion of the Tax on Split Income rules, which applied the top marginal tax rate to dividends from family businesses received by non-exempt spouses. I compare families classified as affected by the reform with those classified as unaffected. Among spouses reporting positive dividends, dividend income falls by about 53% in the treated group relative to controls. Treated spouses also become 16.8 percentage points less likely to report any dividends. Higher owner dividends offset 57% of the dollar decline in spouse dividends, and owner labour income also rises. The reform therefore primarily reallocates reported income within families. Family taxable income falls much less than spouse dividends, while log estimates suggest a modest increase in tax liability. I find little consistent evidence of changes in corporate assets or retained earnings. I also use changes in tax rules applied to fixed 2016 incomes to estimate responsiveness to the relative after-tax return to paying dividends to the spouse rather than the owner. The estimated spouse-dividend elasticity is 1.30 and is similar across family-income groups with access to the same income-shifting channel. This suggests that differences in tax-planning opportunities may help explain the larger taxable-income elasticities often estimated for higher-income taxpayers. Finally, I rank treated families by the additional tax they would owe if they maintained their pre-reform income allocation. Families facing the largest potential penalties show the clearest combination of lower family taxable income and higher tax liability. The reform’s tax consequences therefore depend on prior use of the restricted channel as well as family income.