Save tax by using a family discretionary trust

There are several advantages to setting up a family discretionary trust from tax, legal and personal perspectives. For one, owners-managers can achieve a key objective: Protecting personal assets from potential recourse by creditors.

What is a family discretionary trust?

A family discretionary trust is an inter vivos trust created by and for the members of the same family. The inter vivos trust is a legal vehicle created through a contract (the trust deed) in which a person (the settlor) transfers assets to one or more persons (the trustees) to control those assets for the benefit of other persons (the beneficiaries). Settlors may transfer a variety of assets into the trust, including investment portfolios, shares from a family company, rental properties, a principal residence, etc. Then, according to the level of discretion described in the trust deed, the trustee may allocate trust revenues or capital to one or more of the beneficiaries. Beneficiaries might include the settlor’s spouse, children or grandchildren, or, subject to certain tax rules, the settlor himself. Setting up a family discretionary trust provides many advantages. To make sure that such a strategy meets all your objectives, it’s wise to consult experienced tax and legal advisors. For any questions, please do not hesitate to contact me.

Federal budget makes small businesses even more attractive *

TIM CESTNICK from The Globe and Mail wrote this excellent article regarding the federal budget.

FEDERAL BUDGET

THE TAX RATE

When a company is a Canadian-controlled private corporation (CCPC), which includes most privately held companies in Canada, the company is eligible for an attractive 15.4-per-cent (Canada-wide average; varies by province) rate of tax on its first $500,000 of active business income, thanks to last week's federal budget. The limit was $400,000 prior to the budget. Without getting into the technical jargon, the reason for this low rate of tax is the “small-business deduction,” which reduces the company's effective tax rate.

Consider Matthew's story. Matthew's business, ABC Inc., is expected to earn $500,000 of active business income in 2009. This is the taxable income retained in the company after Matthew has paid himself a salary. The company will pay taxes of about $77,000 (15.4 per cent) on that income, leaving $423,000 in the company after taxes.

But what if Matthew pays some of the $500,000 to himself as additional salary or dividends instead of leaving it in the firm? Consider salary first. If Matthew were to pay some or all of that $500,000 out to himself as additional salary or bonuses, the company would pay less tax since it could deduct the payment. But Matthew would face tax on those dollars personally at about 45 per cent (Canada-wide average), assuming he's in the highest bracket. It doesn't take a rocket scientist to see that 45-per-cent tax in Matthew's hands is much higher than 15.4 per cent in the company.

What about dividends? If Matthew were to pay some of the $500,000 to himself as non-eligible dividends, he would face personal tax on those dollars at about 32.4 per cent (a Canada-wide average) if he's in the highest tax bracket. When you add the tax paid personally on the dividend to the tax paid in the company on the earnings, the combined rate of tax on those dollars paid out as dividends is 42.8 per cent in this complicated example. That's much greater than the 15.4-per-cent hit faced in the company when those dollars are retained in the company.
The bottom line? You'll defer tax by keeping some of your earnings in the company.

THE STRATEGIES

Visiting a tax pro is especially important if your company's taxable income is above $500,000, since you'll have to make decisions about whether to bring your company's taxable income down to the $500,000 limit by paying yourself a bonus, or paying yourself eligible dividends instead. A pro will have to crunch the numbers to determine what's best in your specific situation.

But if your corporate taxable income is $500,000 or less, you'll defer tax by leaving some of those earnings in the company. So, what should you do with those dollars inside your company?
Buy computers. Consider taking advantage of last week's federal budget change that will allow you to deduct 100 per cent of the cost of eligible computers if you acquire them before February, 2011.

Pay salaries to family. If you pay salaries or wages to a family member who has little or no income, the payment will face little or no tax. The pay must be reasonable for the services provided.

Pay tax-free dividends. If an adult shareholder has no other income, it's possible to receive up to about $40,000 (varies by province) in dividends from a Canadian company tax-free thanks to the dividend tax credit.

Repay shareholder loans. If you've lent money to your company in the past, you can take a repayment of any loans at any time on a tax-free basis.

Pay yourself rent. If your company leases space from you in your home, you'll have to report rental income, but can offset much of that income with deductions such as mortgage interest.

Pay capital dividends. To the extent your company has a capital dividend account (CDA) balance, you can receive tax-free dividends from the company. A CDA balance is commonly created when the company realizes capital gains or receives life insurance proceeds.

Dividend to holding company. If your corporation carries on an active business, it can make sense to pay a tax-free intercorporate dividend to a holding company. This can protect that cash from creditors of the business, and provide flexibility in the timing of income to you.