TAX & ESTATE PLANNING FOR BUSINESS OWNERS Wilmot George, CFP, TEP, CHS Director, Tax and Estate Planning
Canadian Small Business Some Stats 1 98% of all employer businesses are small businesses (2010) 48.3% of Canada s workforce work for small businesses (2010) 2.7 million Canadians are self-employed (2010) 28% of Canada s GDP came from businesses with less than 50 employees (2009) Only 24% of small business owners indicate that they have a succession plan for retirement 2 So what? Significant opportunity for advisors to impact our economy by helping to secure small businesses in Canada 1 For this slide a small business is a business with 1 100 employees; Source: Industry Canada/Statistics Canada 2 Source: TD Waterhouse Business Succession Poll (2011) 2
NEW! TAX AND ESTATE PLANNING FOR BUSINESS OWNERS KIT Series of brochures 4 parts Investment, tax and estate planning strategies designed for business owners Integration reference card and Business succession checklist included Ideal investment options for corporate investors 3
Part II: Earning Income In A Corporation
INTEGRATION 101 Income ($) Individual Corporation Personal Tax Corporate Tax Personal Tax Net Cash ($)
Active vs Passive Income Active Business Income (ABI) sales / revenue generated from actively providing a good or service Passive Income Income generated from investments
Active Business Income (ABI) tax rate * First $500,000 (federal) of ABI: Eligible for Small Business Deduction Reduced tax rate on ABI vs. personal rates Difference results in a tax deferral * National Average (2012)
TAX DEFERRAL (2013): BY PROVINCE* Province Small Business Rate (A) Personal Tax Rate (B) Tax Deferral (B-A) British Columbia 13.5% 43.7% 30.2% Alberta 14.0% 39.0% 25.0% Saskatchewan 13.0% 44.0% 31.0% Manitoba 11.0% 46.4% 35.4% Ontario 15.5% 46.4%** 30.9% Quebec 19.0% 49.9% 30.9% New Brunswick 15.5% 43.3% 27.8% Nova Scotia 14.5% 50.0% 35.5% PEI 12.0% 47.4% 35.4% Newfoundland 15.0% 42.3% 27.3% *Rates effective as of Jan 1, 2013 **Ignores 2% tax increase on income in excess of $509,000
Holly owns a printing business which generates $100,000 of business income. She does not need all of this income personally as she has other sources of income. Holly s personal marginal tax rate is 45%. Question: Tax Deferral - Holly s Example How much tax can she defer by earning business income through her corporation as opposed to being self-employed? 9
Active Business Income Active business income Corporate tax After-tax earnings * Personal tax (dividend) Total combined tax Personal tax (if earned personally) Tax Deferral $100,000 $ 15,000 $ 85,000 $ 28,050 $ 43,050 $ 45,000 * Earnings paid out as an ineligible dividend
Active Business Income Active business income Corporate tax After-tax earnings * Personal tax (dividend) Total combined tax Personal tax (if earned personally) Tax Deferral $100,000 $ 15,000 $ 85,000 $ 28,050 $ 43,050 $ 45,000 $ 30,000 * Earnings paid out as an ineligible dividend
ABI: Key Takeaways ABI taxed at low rates in a CCPC Creates an opportunity for significant tax deferral Allows for rapid accumulation of wealth inside a corporation 12
Investment Income As investment assets accumulate in a corporation, they are subject to tax at corporate rates Investment tax rates > ABI rates Investment tax rates > Top personal rates Investment income retains its character High corporate tax rates result in the need for a taxefficient investment solution How is income taxed in a corporation? 13
Overview: Investment Income Taxation in a Corporation Investment Income in a Corporation Interest Income Portion refundable Net To Shareholder Taxable Dividend 14
Overview: Investment Income Taxation in a Corporation Investment Income in a Corporation Interest Income Canadian Dividends Portion refundable Fully Refundable Net To Shareholder Taxable Dividend Eligible Dividend 15
Overview: Investment Income Taxation in a Corporation Investment Income in a Corporation Interest Income Canadian Dividends Capital Gains Portion refundable Fully Refundable Capital Dividend Account Net To Shareholder Taxable Dividend Eligible Dividend Capital Dividend 16
INVESTMENT INCOME IN A CORPORATION (2013) COMBINED CORPORATE / PERSONAL TAX BY PROVINCE* Province Interest Income Dividends Capital Gains British Columbia 45.6% 25.8% 22.8% Alberta 40.7% 19.3% 20.4% Saskatchewan 46.7% 24.8% 23.4% Manitoba 51.3% 32.3% 25.7% Ontario** 45.7% 29.5% 22.9% Quebec 50.8% 35.2% 25.4% New Brunswick 43.3% 22.5% 21.7% Nova Scotia 51.5% 36.1% 25.8% PEI 55.3% 28.7% 27.7% Newfoundland 45.4% 22.5% 22.7% *Rates effective as of Jan 1, 2013 **Ignores 2% tax increase on income in excess of $509,000
Investment Income: Key Takeaways Investment income subject to high corporate tax rates Need for Tax efficiency Avoidance of taxable distributions Focus on capital gains 18
Mackenzie Corporate Class Mutual Funds
Corporate Class Mutual Funds: Key Benefits 1) Tax Efficient Growth 2) Tax Efficient Rebalancing 3) Tax Efficient Income 20
21 Benefit #1: Tax Efficient Growth
22 Benefit #2: Tax Efficient Rebalancing
Corporate Class for Business Owners: Key Takeaways Corporate Class Mutual Funds offer corporate investors: Reduced distributions Tax efficient rebalancing Maximized CDA 23
DRAWING INCOME FROM A CORPORATION
How To Draw Income From A Corporation? DIVIDEND SALARY
How To Draw Income From A Corporation? Salary Less impact to OAS/RRSP room/ipp or RCA Dividends No CPP or EI/Income-splitting/Max charitable donations Capital dividends Tax-free payment from CDA Return of capital (ROC) Tax-free payment if positive PUC
CHANGE TO TAXATION OF NON-ELIGIBLE DIVIDENDS Current Rules: Non-eligible dividends; dividends paid from profits taxed at small business tax rate and; Corporate investment income Gross-up amount = 25% / DTC = 13.33% Budget 2013 Change: Reduce gross-up to 18% and DTC to 11% Effective for non-eligible dividends paid after 2013 Will increase personal tax rate on non-eligible dividends
NON-ELIGIBLE DIVIDENDS IMPACT OF NEW RULES 2013 2014 Non-eligible Dividends $1,000 Gross-up $250 Taxable Dividend $1,250 Federal tax (29%) $363 Dividend tax credit ($167) Net federal tax $196 After-tax proceeds $804 Top federal marginal tax rates 19.59%
NON-ELIGIBLE DIVIDENDS IMPACT OF NEW RULES 2013 2014 Non-eligible Dividends $1,000 $1,000 Gross-up $250 $180 Taxable Dividend $1,250 $1,180 Federal tax (29%) $363 $342 Dividend tax credit ($167) ($130) Net federal tax $196 $212 After-tax proceeds $804 $788 Top federal marginal tax rates 19.59% 21.24%
CHANGE TO TAXATION OF NON-ELIGIBLE DIVIDENDS Impact to Owner-Managers Should owner-managers consider a change to salary/dividend mix? Consider this Meg (Ontario resident) is owner of incorporated business; taxed personally at top rates Requires additional cash to fund an unexpected expense Has choice of additional salary or non-eligible dividend Given the change to the taxation of non-eligible dividends, which option is best? 30
CHANGE TO TAXATION OF NON-ELIGIBLE DIVIDENDS Impact to Owner-Managers Salary Corporate active business income (ABI) $10,000 Additional salary $10,000 Taxable income (corporation) - Additional taxable income (Meg) $10,000 Top marginal tax rate (federal plus Ontario) 46.4% 1 Tax payable $4,640 Net cash flow $5,360 1 Ignores top marginal rate for income beyond $509,000 31
CHANGE TO TAXATION OF NON-ELIGIBLE DIVIDENDS Impact to Owner-Managers Non-eligible dividend (prechange) Corporate ABI $10,000 1 Additional salary paid - Taxable income (corporation) $10,000 Small business tax rate 15.5% Corporate tax $1,550 After-tax profit available for dividend $8,450 Non-eligible dividend MTR 32.6% 2 Personal tax on dividend $2,755 Net cash flow $5,695 Non-eligible dividend (postchange) 1 Eligible for small business tax rate; 2 Ignores top marginal tax rate for income beyond $509,000 32
CHANGE TO TAXATION OF NON-ELIGIBLE DIVIDENDS Impact to Owner-Managers Non-eligible dividend (prechange) Non-eligible dividend (postchange) Corporate ABI $10,000 1 $10,000 1 Additional salary paid - - Taxable income (corporation) $10,000 $10,000 Small business tax rate 15.5% 15.5% Corporate tax $1,550 $1,550 After-tax profit available for dividend $8,450 $8,450 Non-eligible dividend MTR 32.6% 2 34.9% 2 Personal tax on dividend $2,755 $2,949 Net cash flow $5,695 $5,501 1 Eligible for small business tax rate; 2 Ignores top marginal tax rate for income beyond $509,000 33
CHANGE TO TAXATION OF NON-ELIGIBLE DIVIDENDS Impact to Owner-Managers Salary Non-eligible dividend (prechange) Non-eligible dividend (postchange) Net cash flow $5,360 $5,695 $5,501 Tax savings/(cost) - $335 or 3.4% $141 or 1.4% Conclusion Change to non-eligible dividends will increase cost of this cash flow option Many factors to consider when determining best salary/dividend mix (ie. RRSP room, OAS clawback, CPP, payroll taxes) Answer will depend on applicable province and tax rates In several provinces dividends will continue to provide the greater benefit 34
Part III: Retirement Planning For Business Owners
RETIREMENT PLANNING: RRSP VS CORPORATION Q: When saving for retirement, is investing in an RRSP or corporation more efficient? Sole proprietors/partners RRSP Corporate shareholders it depends on: Corporate and personal tax rates Cash flow needs Desire for CPP benefits Income-splitting opportunities 36
RRSP VS CORPORATION: PROS AND CONS Pros: Cons: RRSP Salary/bonus deductible to corporation Contribution and growth taxdeferred Salary (less RRSP contribution) fully taxable personally RRSP income fully taxed on withdrawal Pros: Cons: Corporation Personal tax deferred until dividends paid Dividends and capital gains taxed at preferred rates Investment income taxed annually No CPP benefits or incomesplitting via spousal RRSPs
INVESTING FOR RETIREMENT RRSP (Ontario) RRSP Corporate business income $134,324 1 Less: CPP premium (employer) net cost $1,991 2 Net business income $132,333 Salary paid to owner $132,333 Corporate taxable income - RRSP contribution 3 $ 23,820 Owner s taxable salary (after RRSP contribution) $108,513 Less: Personal tax on salary $ 30,295 4 Less: CPP premium (employee) net cost $1,884 5 Net cash for owner s day-to-day needs $ 76,334 RRSP and CPP premium 15 years later $64,427 6 Tax on RRSP/CPP when received 7 $19,328 RRSP/CPP Net cash to annuitant $45,099 1 Amount required to fund CPP premiums and maximize RRSP contributions; 2 Employer portion of CPP premium less tax savings from corporate deduction; 3 Assumes previous year s income is same as current year; 4 Graduated tax rates (2013); 5 Employee portion of CPP premium less tax savings from personal tax credit; 6 RRSP contribution grown at 6% annually; CPP premium grown at 3% annually; 7 Average tax rate of 30% assumed
INVESTING FOR RETIREMENT CORPORATION (Ontario) Corporation Corporate business income $134,324 1 Less: Corporate tax (small business tax rate) 2 $ 20,820 Corporate retained earnings (before dividend) $113,504 Non-eligible dividend paid to shareholder $ 84,960 3 Less: Personal tax on dividend $ 8,626 Net cash for shareholder s day-to-day needs $ 76,334 Corporate retained earnings (after dividend) $ 28,544 Corporate retained earnings 15 years later 4 $ 68,407 Non-eligible dividend paid to shareholder $ 68,407 Less: Tax on dividend 5 $ 11,021 Corporation Net cash to shareholder $57,386 1 Same as previous chart for comparison purposes ; 2 Small business tax rate of 15.5% (2013); 3 Amount required to achieve same consumption amount as RRSP chart; 4 Growth at 6% annually - corporate class funds, no distributions; 5 Includes corporate tax on capital gain and personal tax on dividend
RETIREMENT PLANNING: RRSP VS CORPORATION (Ontario) Summary RRSP Corporation Net cash for owner s day-to-day needs $76,334 $76,334 Net cash to RRSP annuitant/shareholder $45,099 $57,386 Advantage in retirement $ - $12,287 1 Income subject to small business tax rate? Consider investing corporately Income subject to general tax rate? Consider maximizing RRSP; invest excess corporately Every situation is different; depends on business and owner 1 Based on one year s worth of contributions
Part IV: Estate Planning For Business Owners
ESTATE PLANNING TAXATION AT DEATH Transfer to spouse/clp tax-deferred Transfer to others: Assets/shares deemed sold at death Capital gains tax payable Low ACB & high FMV = Large tax bill Concerns: How will tax be paid? Will business have to be sold? Options for minimizing tax at death?
PLANNING AHEAD? CONSIDER AN ESTATE FREEZE Owner Frozen Shares Owner Voting Shares Family Growth Shares Tax liability reduced via frozen (preferred) shares Voting shares allow for control Growth accrues to family multiply CGE Opco Dividends payable on any shares
PLANNING AHEAD? CONSIDER AN ESTATE FREEZE Advantages Tax liability minimized and defined Allows for income-splitting Allows for planning (ie. funding of liability) Provides succession planning options Preferred shares allow for ongoing dividends Control easily transferred via voting shares Disadvantages Complex to set up Difficult to reverse Can be costly ($5K - $15K depending on complexity)
Personal Services Business (PSB)
PERSONAL SERVICES BUSINESS A corporation used as a substitute for what would normally be an employer-employee relationship Exception applies for corporations that employ more than five full time employees 46
CONTRACTOR OR EMPLOYEE? What defines an employer employee relationship? Numbers of factors: Client controls amount, nature and direction of work Remuneration is by the hour, week or month Worker must work specified hours Services provided for only one client Tools, materials, facilities provided by client 47
CONSEQUENCES OF BEING A PSB Not permitted to claim small business deduction Deductible expenses are restricted i.e., transportation, training of employees, advertising not permitted As of October 31 st, 2011, no longer permitted to claim federal general rate reduction RESULT: Take hike of 13%!! 48
IMPACT OF TAX INCREASE TO PSBs 1 Federal (%) Provincial (%) Total (%) Non-PSB (ABI) 11 4.5 15.5 PSB (pre-change) 15 11.5 26.5 PSB (post-change) 28 11.5 39.5 Employee 29 11.2 46.4 2 Tax-deferral (pre-change) - - Tax-deferral (post-change) - - 1 Rates current to January 2013 for income up to $500,000 for Ontario resident 2 Includes Ontario surtax
IMPACT OF TAX INCREASE TO PSBs 1 Federal (%) Provincial (%) Total (%) Non-PSB (ABI) 11 4.5 15.5 PSB (pre-change) 15 11.5 26.5 PSB (post-change) 28 11.5 39.5 Employee 29 11.2 46.4 2 Tax-deferral (pre-change) - - 19.9 Tax-deferral (post-change) - - 1 Rates current to January 2013 for income up to $500,000 for Ontario resident 2 Includes Ontario surtax
IMPACT OF TAX INCREASE TO PSBs 1 Federal (%) Provincial (%) Total (%) Non-PSB (ABI) 11 4.5 15.5 PSB (pre-change) 15 11.5 26.5 PSB (post-change) 28 11.5 39.5 Employee 29 11.2 46.4 2 Tax-deferral (pre-change) - - 19.9 Tax-deferral (post-change) - - 6.9 1 Rates current to January 2013 for income up to $500,000 for Ontario resident 2 Includes Ontario surtax
IMPACT ON PAYOUT ONTARIO (%) PSB (pre-change) 48.2 1 PSB (post-change) 57.4 2 Employee 46.4 Savings/(cost) pre-change Savings/(cost) post-change 1 Combined (corporate and personal) tax rate for 2013 with 13% tax rate reduction 2 Combined (corporate and personal) tax rate for 2013 without 13% tax rate reduction
IMPACT ON PAYOUT ONTARIO (%) PSB (pre-change) 48.2 1 PSB (post-change) 57.4 2 Employee 46.4 Savings/(cost) pre-change (1.8) Savings/(cost) post-change 1 Combined (corporate and personal) tax rate for 2013 with 13% tax rate reduction 2 Combined (corporate and personal) tax rate for 2013 without 13% tax rate reduction
IMPACT ON PAYOUT ONTARIO (%) PSB (pre-change) 48.2 1 PSB (post-change) 57.4 2 Employee 46.4 Savings/(cost) pre-change (1.8) Savings/(cost) post-change (11.0) 1 Combined (corporate and personal) tax rate for 2013 with 13% tax rate reduction 2 Combined (corporate and personal) tax rate for 2013 without 13% tax rate reduction
PSB: Does Incorporating Make Sense? If business will be considered PSB, does incorporating make sense? If owner will spend all earnings personally each year, employee-employer (or sole proprietor) status is typically better (from a tax perspective) If owner can arrange for more control/risk over work, PSB status may be avoided If business is currently a PSB, consider regular bonuses/salaries to avoid PSB tax rates 55
QUESTIONS?