The end of the year provides a great opportunity for business owners to consider ways to improve their tax position. As a business owner, there’s still time to manage taxes for yourself and your business for 2017 before the end of the year. It is particularly important this year that you consider year-end tax planning keeping in mind the government’s private company tax proposal which may result in increased taxes in 2018 for private companies and their shareholders.
New tax rules for private companies are on their way
While you carry out your review this year, keep in mind that in 2018 the way private companies and their shareholders are taxed will be changing. In the summer of 2017, Finance Minister Bill Morneau released a number of tax proposals for small businesses, which have since been updated in October 2017. The updated reforms include changes to the “reasonable test” for income splitting/sprinkling and passive investments inside of a private corporation,
As a business owner, you should be aware of how these changes will affect your company and your financial situation. Please set up a meeting with us and your tax advisor before the end of the year to review how these changes will affect your situation.
Effective Dividend/Salary Mix
You can receive corporate income as salary or dividends as the owner of an incorporated business. Deciding on what’s best for you this year, you must analyze the optimal mix of salary and dividends for you, which depends on several factors including:
- Your cash flow needs (current and future)
- Your income level
- Payroll taxes on salary
- The corporation’s income level
- The possible effects of the private company proposals on you and your company.
You may want to pay yourself enough salary to contribute as much as you possibly can towards an RRSP. The same goes for any family member employed by you. The maximum contribution you can make is 18% of the previous year’s earned income, up to a limit of $26,010 for 2017 and $26,230 for 2018. Keep in mind that the salary paid must be reasonable for your company to get a tax deduction.
The downside to this, is that if your business is in a situation where you can suffer from economic downturn, then paying out a big salary in a profitable year will reduce the likelihood of recovering corporate taxes paid, if a loss materializes.
Family employment – Paying a salary to your family
You may want to consider employing your family members and paying them an appropriate salary if they provide services to your incorporated business. The business will benefit from a tax deduction on the salary paid, as long as it is reasonable in light of the services they provide (Example: administrative work, bookkeeping, acting director). Usually, a salary is considered “reasonable” if the services are genuinely being provided and the salary is similar to arms’ length comparables. Remember to weigh in the costs of payroll taxes and CPP contributions against the potential tax savings.
Family members who hold shares in your company
Consider paying additional dividends in 2017 to your family members who hold shares in your company, before the new tax on split income regime comes into effect in 2018. If the dividends amount these individuals receive is “unreasonable” under the circumstances, they will be taxed at the top marginal tax rate (regardless of their own personal tax rate).
The new proposed rules are targeted at family members aged 18-24. The “reasonableness test” examines labour and capital contributions to the business, risk assumed and previous remuneration.
You should review your tax situation with your tax advisor including your family company’s organizational structure on a go-forward basis to ensure you satisfy the new “reasonableness test”.
Does the small business deduction affect you?
Can your business claim a small business deduction? The current small business deduction is $500,000. The small business tax deduction will be worth more to your company this year than it will be in 2018, because the small business tax rate will be decreasing from 10.5% in 2017 to 10% in 2018 and will be down to 9% in 2019.
If your corporate group claimed more than one small business deduction, the 2016 federal budget introduced several changes which were intended to limit the multiplication of the small business deduction through the use of certain partnerships and corporations. Please review this with your tax advisor.
When to pay dividends: 2017 or 2018?
Deciding if to pay dividends in 2017 or 2018, consider that the income tax rate for non-eligible dividends (generally, dividends that are paid from a company’s income that were taxed at the small business tax rate or as interest income) is increasing slightly in 2018. The federal tax rate is going up 0.34% from 26.30% in 2017 to 26.64% in 2018. A non-eligible dividend of, say, $100,000 out of your company in 2018 can save you at least $340 in absolute tax savings if paid in 2017 instead. These savings can be even higher if the provinces also announce increases to their 2018 tax rates for non-eligible dividends. The following provinces have announced increases: Ontario, New Brunswick and British Columbia.
Please also note that the top personal rate is also increasing.
Are you affected by the new passive income tax regime?
The rules being introduced by the government in 2018 can potentially eliminate the financial advantages of investing passively through a private corporation. As a result of these rules, it will soon become less beneficial to earn investment income in a company and distribute non-eligible dividends, than it will be to earn investment income personally. More details are expected to be announced in the Federal Budget 2018. The government made an announcement on October 18, 2017, that passive investment income below a $50,000 annual would face no tax increase and confirmed that the new rules would apply on a “go-forward basis”. According to the government this $50,000 threshold is intended to allow you to build up passive investments to help cover things like income fluctuations, start-up costs or maternity leave. The government has also stated that passive investments that have already been made by private corporations’ owners will be “protected” (this includes future income earned from these investments). There is still clarification required on when these rules will take effect and how the government intends to implement these new rules.
This is in an imperative year to do a year-end review of your personal and business finances. Talk to your advisor, they can help. If you would like to be referred to an advisor, please let us know.
It has certainly been a busy week in terms of announcements regarding financial policies for small businesses. Following the series of proposed tax reforms that the government announced back in July, various tweaks and changes have subsequently been made, owing, perhaps in part, to confusion and frustration expressed among the small business community. This week Finance Minister, Bill Morneau, has made further clarifications and adjustments to his original set of proposals, aiming to bring more of a sense of balance to the plans. Like all policy changes, the detail can be a little overwhelming, so here is a summary of the key points for your reference:
- The government intends to honor a commitment made prior to the election, to reduce the small business tax rate from 10.5% to 9% by the year 2019.
- Morneau confirmed that the government has scrapped the proposal to limit access to the Lifetime Capital Gains Exemption.
- The plans announced earlier in the year to reduce the value of passive investments made by corporations will continue in principle, but with few key changes. There will be a threshold of $50,000 of income per year, which will be excluded from the newly set higher rate of tax.
- The government has agreed to “simplify” the rules related to the new plans, to prevent income splitting for family members, who are not active in a business, but the plan will still move ahead in principle.
- Morneau has confirmed that the government will still provide good entrepreneurial incentives for venture capitalists and angel investors. The criteria for which still needs to be established.
- The proposed rules to limit the conversion of income to capital gains have been abandoned due to the concerns that many related to intergenerational transfers and insurance policies were held inside corporations.
Of course, this is one area of government policy which is not only constantly changing, but particularly controversial in the current climate, so keep yourself updated regularly on new announcements and news, to ensure your understanding in this area and its potential impact on your family and business. If you have any questions, please talk to us.