As we all know, Dec. 31st is coming real fast and I advise all my clients to ensure that they doing some year end tax planning. Below is a great summary prepared by the accounting firm, Bessner Gallay Kreisman LLP. As usual, please do not hesitate to contact me directly should you have any questions.
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2010 YEAR END TAX PLANNING
Salary/Dividend Planning
Many factors must be considered in determining the most beneficial combination of remunerating the owner/manager of a closely-held corporation. As with other planning, each case must be examined separately and no one "rule of thumb" can apply to all situations.
Here are a few factors that should be taken into consideration:
• The tax rate of the corporation
• The marginal tax rate of the individual
• Exposure to Alternative Minimum Tax
• The ability to benefit from child care expenses, paternity/maternity benefits and to make RRSP and CPP/QPP contributions is based on salary and not dividend income
• Wage levies applicable to salaries, such as the Ontario Employer Health Tax and Quebec's Health Services Fund and 1% Training Tax (if the payroll exceeds $1,000,000)
• Quebec restrictions on the deductibility of investment expenses by individuals where expenses exceed investment income
• Whether eligible dividends can be paid to shareholders
• Full or partial loss of the dividend credit if taxable income is not high enough
• Higher net income with a dividend than with a salary, as dividend income is grossed up by 44% or 25% (depending on whether the dividend is eligible or not) which can have an impact on certain credits and benefits
Some planning techniques include:
• If the corporation has Refundable Dividend Tax on Hand (RDTOH), the payment of a dividend will result in a refund of 33 1/3% of the dividend payment up to a maximum of the RDTOH balance
• Remuneration that is accrued and expensed by a corporation must be paid to the employee within 179 days of the corporation's year-end. When a year-end falls after July 5, the corporation can cause the owner/manager's remuneration to fall into either the current or subsequent calendar year
Freeze or Refreeze?
An estate freeze is used to ensure that future growth in the value of a company accumulates in the hands of a shareholder's heirs. This is accomplished by "freezing" the current fair market value of the company in the form of preferred shares. If the value of a business subsequently decreases, the benefits of freezing may not be fully realized and it may be advantageous to consider "unfreezing" and "refreezing" a company.
Refreezing enables taxpayers to exchange their old preferred shares, obtained at the time of the initial freeze, for new shares with a lower redemption price. Any future gains in value will then be passed on to the holders of common shares. This type of planning helps reduce tax on the death of taxpayers by lowering the redemption price of their preferred shares and transferring more value to their heirs.
Income Splitting
Investment income earned by an individual who invested money borrowed at low or no interest from a related person will be attributed back to the lender. Subject to a purpose test, this rule does not apply where the loan is to a related person other than a spouse or minor child. Nor will it apply where the loan is to a spouse or minor child if interest is charged at the prescribed rate in effect at the time the loan is made (the prescribed rate for the fourth quarter of 2010 is 1%). When utilizing this exception, interest must be paid no later than 30 days after the end of the year to avoid attribution of income.
For instance, the high-income spouse could lend investment funds to the low-income spouse at the current 1% rate and receive (and pay tax on) the interest income each year, for as long as the loan remains outstanding. The low-income spouse would pay tax on the income generated by the funds and deduct the interest paid to the high-income spouse.
Since the attribution rules are complex, caution is advised when contemplating a transfer of property or a loan to a spouse or a child (including transfers indirectly through a corporation or a trust).
Some other basic planning ideas would include:
• Gifting growth assets to a minor child, as the resulting capital gain is not attributed to the donor
• Gifting property to a child who is not a minor
• Segregating and re-investing "attributed" income of a spouse or minor child
• Deposit Canada Child Tax Benefit (CCTB), Universal Child Care Benefit (UCCB) and Quebec Child assistance payments (CAP) directly into accounts opened in the children's names
• Use the income of the spouse with the higher income to pay all the family's expenses so that the spouse with the lower income has more capital available for investment
• Using a trust for the benefit of family members to hold shares of a closely-held corporation. However, there are restrictions in regard to income-splitting with minor children
• Spouses can choose to share their QPP and CPP retirement pensions
• Have your spouse as your business partner or pay reasonable salaries to your spouse or children
Shareholder Loans
Any loan granted by a corporation to an individual who is a shareholder or to a person with whom the shareholder does not deal at arm's length will be taxable in the year in which the loan is advanced, unless a particular exception applies.
If the loan meets one of these exceptions, the shareholder will be required to pay to the corporation interest at a rate at least equal to the prescribed rate no later than January 30 each year. If a shareholder loan exists at any time during the year, a taxable benefit must be calculated based on the prescribed interest rate, less the interest actually paid.
When a loan is repaid, the shareholder may claim a deduction up to the amount that had been included in income. It might be worthwhile for a corporation to make a loan to an adult child of the shareholder at a time when the child does not have much income. The loan may be repaid in a subsequent year, when the child's marginal tax rate is higher.
Since shareholder loans are not deductible from a corporation's income and do not generate refunds of RDTOH it is recommended that shareholders verify whether it would be more advantageous to be paid a salary or a dividend. It is very important that any loan contract between a corporation and one of its shareholders be adequately documented.
Capital Gains Exemption
A capital gains exemption is available for individuals to use in relation to gains realized on qualified small business corporation shares and some other properties. The maximum lifetime capital gain exemption is $750,000. Be aware of the possible disadvantage of selling investments eligible for the $750,000 capital gains exemption and investments with losses in the same year. Capital losses realized in the year must be offset against capital gains of that year including "exempt" gains. Consider selling investments with losses the following year. Subject to certain conditions an individual may defer capital gains on eligible small business investments to the extent that the proceeds are reinvested in another eligible small business. The reinvestment must be made at any time in the year of disposition or within the first 120 days of the following year.
Acquisition of Assets
Accelerate the acquisition of depreciable property used in carrying on a business otherwise planned for the beginning of the next year. This will allow additional depreciation (CCA) to be claimed in the current year. The "available-for-use rules" should be considered (generally requiring the depreciable property to be used in operations for the depreciation deduction to be allowed).
Conversely, consider delaying until the subsequent year the acquisition of depreciable property in a class that would otherwise have a terminal loss in the current year.
Eligible new computers and software acquired before February 2011 are entitled to a capital cost allowance of 100% the first year in which the assets are available for use. Computers purchased after January 2011 will revert to a CCA rate of 55% and be subject to the half-year rule.
Death Benefit
A corporation can make a onetime tax free payment of up to $10,000 to the spouse or heirs of a deceased employee. This payment will not be taxable to the recipient and will be fully deductible by the corporation.
Monday, November 29, 2010
Monday, November 22, 2010
Doctors: What are the Tax Advantages of a Physician Professional Corporation?
Why Have a Professional Corporation (“PC”)
Physicians who carry on their medical practice in Ontario personally pay income tax at a rate in excess of 46%. Such physicians are not permitted to split income with family members, except to pay “reasonable salaries” to family members who provide actual services to the practice. Such salaries are frequently attacked by Canada Revenue Agency (“CRA”). By incorporating a PC to carry on the medical practice, a physician can achieve significant tax advantages by way of paying tax at a much lower corporate tax rate (18.6% rather than 46.4%) and income splitting with family members by paying dividends (which themselves are taxed at a lower rate).
What are the Legal Requirements for a PC?
A PC is incorporated under the Ontario Business Corporation Act (the “OBCA”) as a regular corporation. However, a PC is subject to a number of special rules and restrictions pursuant to the OBCA and the Regulated Health Professions Act. Some of the key restrictions and requirements are as follows:
A physician must be the sole director, officer and own all of the shares with general voting rights;
The name of the corporation must include the physician’s surname plus “Medicine Professional Corporation”; Other family members (spouse, children, parents and trust for minor children) can own non-voting shares(recent change to legislation);
A Certificate of Authorization for the PC from the College of Physicians and Surgeons of Ontario is required;
The physician remains personally liable for all professional matters relating to the practice; and
The activities of the PC must be limited to carrying on a professional medical practice (and related matters and investments).
Are There Any Non-Tax Advantages
The main advantages and reasons for establishing a PC are income tax related. However, although the physician remains personally liable for professional matters, the PC does offer some advantages of limited liability for non-professional matters, such as if the PC borrows money and enters into agreements, such as an office lease and equipment leases.
How does the Lower Corporate Tax Rate Result in Tax Savings
A corporation (including a PC) can earn up to $500,000 per year of active business income at the 17.6% tax rate. This provides a tax savings of approximately 28.8%, compared to the personal tax rate in Ontario that applies if the physician earns the practice income personally (46.4%). This lower tax rate applies only to income left behind in the PC.
What Can You do with Money Left over in a PC
There are a number of efficient uses for the extra after-tax dollars left in the PC. If, for example, a physician is able to leave $50,000 of profit per year in the PC, there will be significant tax savings. The after-tax amount left to invest inside the PC would be approximately $40,700, rather than $26,800, if the $50,000 was earned personally by the physician. This represents a tax savings of $13,900 per year. This after-tax amount can be invested in the PC the same way it would be invested personally by the physician and provides an excellent, tax-efficient method to build up investments more quickly and save for retirement.
Also, the additional after-tax income left in the PC allows the PC to pay off debts more quickly than if the income was earned personally by the physician and provides a tax-efficient method to pay certain non-deductible expenses (life insurance premiums and some entertainment expenses).
How Can You Income Split with a PC
Physicians are allowed to split income with other family members, such as a spouse, parents, children and trusts for minor children. The income splitting is achieved by having the family members own non-voting shares of the PC that can receive dividends as determined by the physician. Dividends are taxed more favourably than other types of income. An individual with no other income can receive up to approximately $32,000 of dividends tax-free. Dividends can be paid most tax-efficiently to family members who do not have significant other income.
What Factors do you need to Consider when setting up the Share Structure:
It is extremely important that the share structure of the PC be set up with advance planning at the outset, in consideration of the following:
Flexibility for changing circumstances of family members;
Flexibility to pay dividends to whatever family members are selected each year by the physician;
Ensuring that the physician retains complete control of the PC;
Allowing the physician to cancel the shares of family members if the circumstances warrant (i.e. marital problems);
Establishment at the time of incorporation of multiple classes of shares, so there is a separate class for each family member (allowing complete flexibility as to dividends payable to each family member); and
Establishing special classes of shares to be issued to the physician on the transfer of goodwill and other assets relating to the practice, such as equipment.
Are There Any Other Tax Advantages
The most significant tax advantages available to a PC are generally the corporate tax rate advantage and the income splitting advantage. However, there are additional possible tax advantages, such as creating an individual pension plan, tax deferral (to next year) by bonus accruals, use of non-calendar year end, no GST payable on dividends and no requirement for dividend recipients to perform reasonable (i.e. any) services.
How Can You Transfer Assets and Agreements to the PC
Since the medical practice will be carried on by the PC, it is necessary to consider what assets and agreements need to be transferred from the physician to the PC. In order to avoid possible tax problems, it is necessary that goodwill relating to the medical practice be transferred from the physician to the PC. Also, it is necessary to consider if there are other assets, such as equipment to be transferred to the PC. Finally, one must consider what agreements there are relating to the practice, such as office lease and equipment leases, which should be transferred to the PC.
Summary
A PC can offer significant income tax savings to a physician. However, it is important that there be proper tax planning in advance by the physician, accountant and lawyer. On the legal front, the lawyer must implement the corporate share structure properly, in order to achieve the maximum tax savings, provide the most flexibility for changing circumstances and to avoid the various tax traps that can apply.
If you would like to consider the suitability of a PC for your situation, please contact me.
Physicians who carry on their medical practice in Ontario personally pay income tax at a rate in excess of 46%. Such physicians are not permitted to split income with family members, except to pay “reasonable salaries” to family members who provide actual services to the practice. Such salaries are frequently attacked by Canada Revenue Agency (“CRA”). By incorporating a PC to carry on the medical practice, a physician can achieve significant tax advantages by way of paying tax at a much lower corporate tax rate (18.6% rather than 46.4%) and income splitting with family members by paying dividends (which themselves are taxed at a lower rate).
What are the Legal Requirements for a PC?
A PC is incorporated under the Ontario Business Corporation Act (the “OBCA”) as a regular corporation. However, a PC is subject to a number of special rules and restrictions pursuant to the OBCA and the Regulated Health Professions Act. Some of the key restrictions and requirements are as follows:
A physician must be the sole director, officer and own all of the shares with general voting rights;
The name of the corporation must include the physician’s surname plus “Medicine Professional Corporation”; Other family members (spouse, children, parents and trust for minor children) can own non-voting shares(recent change to legislation);
A Certificate of Authorization for the PC from the College of Physicians and Surgeons of Ontario is required;
The physician remains personally liable for all professional matters relating to the practice; and
The activities of the PC must be limited to carrying on a professional medical practice (and related matters and investments).
Are There Any Non-Tax Advantages
The main advantages and reasons for establishing a PC are income tax related. However, although the physician remains personally liable for professional matters, the PC does offer some advantages of limited liability for non-professional matters, such as if the PC borrows money and enters into agreements, such as an office lease and equipment leases.
How does the Lower Corporate Tax Rate Result in Tax Savings
A corporation (including a PC) can earn up to $500,000 per year of active business income at the 17.6% tax rate. This provides a tax savings of approximately 28.8%, compared to the personal tax rate in Ontario that applies if the physician earns the practice income personally (46.4%). This lower tax rate applies only to income left behind in the PC.
What Can You do with Money Left over in a PC
There are a number of efficient uses for the extra after-tax dollars left in the PC. If, for example, a physician is able to leave $50,000 of profit per year in the PC, there will be significant tax savings. The after-tax amount left to invest inside the PC would be approximately $40,700, rather than $26,800, if the $50,000 was earned personally by the physician. This represents a tax savings of $13,900 per year. This after-tax amount can be invested in the PC the same way it would be invested personally by the physician and provides an excellent, tax-efficient method to build up investments more quickly and save for retirement.
Also, the additional after-tax income left in the PC allows the PC to pay off debts more quickly than if the income was earned personally by the physician and provides a tax-efficient method to pay certain non-deductible expenses (life insurance premiums and some entertainment expenses).
How Can You Income Split with a PC
Physicians are allowed to split income with other family members, such as a spouse, parents, children and trusts for minor children. The income splitting is achieved by having the family members own non-voting shares of the PC that can receive dividends as determined by the physician. Dividends are taxed more favourably than other types of income. An individual with no other income can receive up to approximately $32,000 of dividends tax-free. Dividends can be paid most tax-efficiently to family members who do not have significant other income.
What Factors do you need to Consider when setting up the Share Structure:
It is extremely important that the share structure of the PC be set up with advance planning at the outset, in consideration of the following:
Flexibility for changing circumstances of family members;
Flexibility to pay dividends to whatever family members are selected each year by the physician;
Ensuring that the physician retains complete control of the PC;
Allowing the physician to cancel the shares of family members if the circumstances warrant (i.e. marital problems);
Establishment at the time of incorporation of multiple classes of shares, so there is a separate class for each family member (allowing complete flexibility as to dividends payable to each family member); and
Establishing special classes of shares to be issued to the physician on the transfer of goodwill and other assets relating to the practice, such as equipment.
Are There Any Other Tax Advantages
The most significant tax advantages available to a PC are generally the corporate tax rate advantage and the income splitting advantage. However, there are additional possible tax advantages, such as creating an individual pension plan, tax deferral (to next year) by bonus accruals, use of non-calendar year end, no GST payable on dividends and no requirement for dividend recipients to perform reasonable (i.e. any) services.
How Can You Transfer Assets and Agreements to the PC
Since the medical practice will be carried on by the PC, it is necessary to consider what assets and agreements need to be transferred from the physician to the PC. In order to avoid possible tax problems, it is necessary that goodwill relating to the medical practice be transferred from the physician to the PC. Also, it is necessary to consider if there are other assets, such as equipment to be transferred to the PC. Finally, one must consider what agreements there are relating to the practice, such as office lease and equipment leases, which should be transferred to the PC.
Summary
A PC can offer significant income tax savings to a physician. However, it is important that there be proper tax planning in advance by the physician, accountant and lawyer. On the legal front, the lawyer must implement the corporate share structure properly, in order to achieve the maximum tax savings, provide the most flexibility for changing circumstances and to avoid the various tax traps that can apply.
If you would like to consider the suitability of a PC for your situation, please contact me.
Thursday, November 18, 2010
Taxman cracks down on IT consultants
Today I would like to share an interesting article written by Peter Kovessy from the Ottawa Business Journal. If you are in this situtation, I encourage you to contact me to review your situation before you get audited by CRA. Its important to have the proper agreement in place, the right set of facts, etc.
Government ignoring committee’s call to recognize realities of ‘modern labour market’
Thousands of local IT consultants are facing hefty tax reassessments as the Canada Revenue Agency reexamines their relationship with staffing agencies that help connect them to the federal government, experts say.
In recent months, the CRA has started “aggressively” auditing these incorporated businesses and ruling their role is more like an employee of a staffing firm than an independent contractor.
The financial stakes for these consultants are said to be high, with some facing reassessed tax bills of up to $50,000, say those involved in the fight with CRA.
If these businesses are deemed to be what the tax agency terms “personal services businesses,” they can no longer claim business expenses – such as office space, supplies and training – as deductions on their taxes. It also means they’re no longer eligible for the favourable small-business tax rate, adding a further financial strain.
“It can have such a significant impact in this town,” says Doug McLarty, managing director of accounting and financial services firm McLarty & Co.
While the frustrations of IT consultants may currently be directed at the CRA, a 1960s-era CFL coach may actually be at the root of the problem.
Ralph Sazio, who led the Hamilton Tiger-Cats to three Grey Cup championships, felt he would be better off tax-wise if he incorporated himself and contracted his services to the football club, says Gowlings partner and tax lawyer Mark Siegel, who represents a “fair number” of IT consultants fighting their reassessments.
He says the tax agency took the case to court and lost, prompting new rules that prevented individuals who incorporate themselves – but perform the functions of an employee – from realizing the tax benefits of a small business.
Government downsizing in the 1990s resulted in many federal bureaucrats becoming consultants to their former employer, especially in the IT sector. Rather than dealing with thousands of individual contracts, the government moved to a relatively small number of standing offers with staffing firms, which in turn subcontracted the consultants.
But Mr. Siegel says the CRA decided in the early 2000s that the consultants were more like employees than independent contractors of the staffing firms, which were then on the hook to make CPP and EI contributions.
To avoid these costs, many staffing firms then required consultants to be incorporated companies if they wanted work, according to Mr. Siegel.
But in 2009, the CRA started taking a different view of many of these independent corporations, observers say.
“They are reassessing these (individuals) – mainly IT consultants – who have created corporations (and) are providing their services, generally, through a staffing agency to federal government departments,” says Mr. Siegel.
“They’re between a rock and a hard place. If the assessment were to come along, a normal person would say, ‘I won’t be incorporated anymore.’ But then the staffing agencies won’t hire them.”
Jennifer Smith, an executive director in the Ottawa tax practice with Ernst & Young LLP, says incorporated individuals deemed to be personal services businesses face a double financial hit.
First, they can no longer deduct normal business expenses incurred while earning revenues.
They’re also ineligible for the favourable 15.5-per-cent tax rate on the first $500,000 of active business income, which is substantially lower than what an individual is taxed.
The CRA weighs several factors in determining whether an incorporated individual is an employee or an independent contractor, such as the degree of financial risk taken, level of control, and the opportunity for profit.
Mr. McLarty adds contractors who do the bulk of their work at a single department are at a higher risk than those with multiple clients.
Federal politicians are aware of the problems caused by the CRA’s new interpretation.
In June, the House of Commons finance committee released a report calling on the government to change the Income Tax Act to reflect “the realities of the modern labour market, particularly in terms of small information technology companies, in order to ensure tax fairness for those small business owners who are deemed to be ‘incorporated employees.’” The recommendation has so far been ignored.
Those representing the affected IT firms say they’re simply seeking clarity for their clients.
“These people are are facing tax bills they can’t pay ... (the CRA is) destroying entrepreneurship in the IT sector,” says Serge Buy, a lobbyist for CABiNET, which represents IT professional service providers in the National Capital Region.
“There should be clear rules that allow you to establish your business practices in a stable way.”
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Common-law tests of whether an individual is an employee or an independent contractor:
-The level of control the employer or hirer has over the worker's activities;
-Whether the worker provides his or her own equipment;
-Whether the worker hires his or her own helpers;
-The degree of financial risk taken by the worker;
-The degree of responsibility for investment and management undertaken by the worker;
-The worker's opportunity for profit (or risk of loss) in the performance of his or her tasks; and
-The intention of the parties, as expressed in the relevant documentation and by their actions.
Source: Ernst & Young
Government ignoring committee’s call to recognize realities of ‘modern labour market’
Thousands of local IT consultants are facing hefty tax reassessments as the Canada Revenue Agency reexamines their relationship with staffing agencies that help connect them to the federal government, experts say.
In recent months, the CRA has started “aggressively” auditing these incorporated businesses and ruling their role is more like an employee of a staffing firm than an independent contractor.
The financial stakes for these consultants are said to be high, with some facing reassessed tax bills of up to $50,000, say those involved in the fight with CRA.
If these businesses are deemed to be what the tax agency terms “personal services businesses,” they can no longer claim business expenses – such as office space, supplies and training – as deductions on their taxes. It also means they’re no longer eligible for the favourable small-business tax rate, adding a further financial strain.
“It can have such a significant impact in this town,” says Doug McLarty, managing director of accounting and financial services firm McLarty & Co.
While the frustrations of IT consultants may currently be directed at the CRA, a 1960s-era CFL coach may actually be at the root of the problem.
Ralph Sazio, who led the Hamilton Tiger-Cats to three Grey Cup championships, felt he would be better off tax-wise if he incorporated himself and contracted his services to the football club, says Gowlings partner and tax lawyer Mark Siegel, who represents a “fair number” of IT consultants fighting their reassessments.
He says the tax agency took the case to court and lost, prompting new rules that prevented individuals who incorporate themselves – but perform the functions of an employee – from realizing the tax benefits of a small business.
Government downsizing in the 1990s resulted in many federal bureaucrats becoming consultants to their former employer, especially in the IT sector. Rather than dealing with thousands of individual contracts, the government moved to a relatively small number of standing offers with staffing firms, which in turn subcontracted the consultants.
But Mr. Siegel says the CRA decided in the early 2000s that the consultants were more like employees than independent contractors of the staffing firms, which were then on the hook to make CPP and EI contributions.
To avoid these costs, many staffing firms then required consultants to be incorporated companies if they wanted work, according to Mr. Siegel.
But in 2009, the CRA started taking a different view of many of these independent corporations, observers say.
“They are reassessing these (individuals) – mainly IT consultants – who have created corporations (and) are providing their services, generally, through a staffing agency to federal government departments,” says Mr. Siegel.
“They’re between a rock and a hard place. If the assessment were to come along, a normal person would say, ‘I won’t be incorporated anymore.’ But then the staffing agencies won’t hire them.”
Jennifer Smith, an executive director in the Ottawa tax practice with Ernst & Young LLP, says incorporated individuals deemed to be personal services businesses face a double financial hit.
First, they can no longer deduct normal business expenses incurred while earning revenues.
They’re also ineligible for the favourable 15.5-per-cent tax rate on the first $500,000 of active business income, which is substantially lower than what an individual is taxed.
The CRA weighs several factors in determining whether an incorporated individual is an employee or an independent contractor, such as the degree of financial risk taken, level of control, and the opportunity for profit.
Mr. McLarty adds contractors who do the bulk of their work at a single department are at a higher risk than those with multiple clients.
Federal politicians are aware of the problems caused by the CRA’s new interpretation.
In June, the House of Commons finance committee released a report calling on the government to change the Income Tax Act to reflect “the realities of the modern labour market, particularly in terms of small information technology companies, in order to ensure tax fairness for those small business owners who are deemed to be ‘incorporated employees.’” The recommendation has so far been ignored.
Those representing the affected IT firms say they’re simply seeking clarity for their clients.
“These people are are facing tax bills they can’t pay ... (the CRA is) destroying entrepreneurship in the IT sector,” says Serge Buy, a lobbyist for CABiNET, which represents IT professional service providers in the National Capital Region.
“There should be clear rules that allow you to establish your business practices in a stable way.”
-------
Common-law tests of whether an individual is an employee or an independent contractor:
-The level of control the employer or hirer has over the worker's activities;
-Whether the worker provides his or her own equipment;
-Whether the worker hires his or her own helpers;
-The degree of financial risk taken by the worker;
-The degree of responsibility for investment and management undertaken by the worker;
-The worker's opportunity for profit (or risk of loss) in the performance of his or her tasks; and
-The intention of the parties, as expressed in the relevant documentation and by their actions.
Source: Ernst & Young
Thursday, November 11, 2010
Business Owners: Income Splitting 101 & How can you reduce your tax burden with some Income Splitting" strategies?
if you follow my blog, you know that I enjoy reading Tim Cesnick's article published in the Globe & Mail. Once again, Tim's article is a MUST read for all of you. As usual, please do not hesitate to contact me should you wish to discuss some personal tax strategies.
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The Concept
Income splitting is one of the pillars of tax planning. It involves moving income from the hands of one family member who will pay tax at a higher rate to the hands of someone else in the family who will pay tax at a lower rate. By taking advantage of the lower tax brackets of family members, the overall tax burden for the family can be reduced.
How much tax can be saved? It varies by province, but the average across Canada is $17,000 in potential tax savings annually per family member. Your actual savings will depend on your level of income, your family member’s level of income, and your province of residence. The provinces where the greatest annual tax savings are possible are Nova Scotia ($21,000), Ontario ($19,565) and B.C. ($18,908). Alberta offers the smallest opportunity for annual savings at $13,196.
The Challenge
Here’s the problem: The attribution rules in our tax law are designed to prevent you from simply moving income to someone else’s hands. If you’re caught under these rules, the income earned by your family member will be attributed back to you to be taxed in your hands. The most common situations where these nasty rules will apply are where you give or lend money (at no or low interest) to your spouse or minor children.
The good news? There are quite a few strategies that can be implemented to split income that will sidestep the attribution rules.
The Strategies
Set yourself up for tax savings next year with one of these ideas:
1. Lend money to your spouse or child. You can simply lend money to your spouse or a child for them to invest. In the case of your spouse, all income and capital gains will be attributed back to you, and in the case of minor children, all income (but not capital gains) will face tax in your hands. But second generation income (that is, income on the income) will not be attributed back to you. It makes sense to move the income annually into a separate account so that its growth can be tracked separately from the original loan amount.
2. Lend money to family at interest. This idea is much the same as the one above, except that you can charge interest on the loan to avoid the attribution rules. By charging the prescribed rate of interest (currently just 1 per cent) your family member, not you, will face tax on any income earned. Your family member will have to pay you the interest every year by Jan. 30 for the prior year’s interest charge (if this is overlooked even once, the attribution rules will apply every year going forward). And get this: The current prescribed rate can be locked in indefinitely. So, if you set this loan up before Dec. 31 of this year, the 1-per-cent rate can apply forever. To the extent your family member earns more than 1 per cent on the funds, you’ll effectively split income.
3. Lend or give money to acquire a principal residence. If you help a family member to purchase a home, this will free up the income of that family member for other purposes – such as investing – effectively moving investable assets from your hands to theirs. In addition, if the property appreciates in value, the capital gain could be sheltered using the principal residence exemption of your family member if they are older than 18 or married.
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The Concept
Income splitting is one of the pillars of tax planning. It involves moving income from the hands of one family member who will pay tax at a higher rate to the hands of someone else in the family who will pay tax at a lower rate. By taking advantage of the lower tax brackets of family members, the overall tax burden for the family can be reduced.
How much tax can be saved? It varies by province, but the average across Canada is $17,000 in potential tax savings annually per family member. Your actual savings will depend on your level of income, your family member’s level of income, and your province of residence. The provinces where the greatest annual tax savings are possible are Nova Scotia ($21,000), Ontario ($19,565) and B.C. ($18,908). Alberta offers the smallest opportunity for annual savings at $13,196.
The Challenge
Here’s the problem: The attribution rules in our tax law are designed to prevent you from simply moving income to someone else’s hands. If you’re caught under these rules, the income earned by your family member will be attributed back to you to be taxed in your hands. The most common situations where these nasty rules will apply are where you give or lend money (at no or low interest) to your spouse or minor children.
The good news? There are quite a few strategies that can be implemented to split income that will sidestep the attribution rules.
The Strategies
Set yourself up for tax savings next year with one of these ideas:
1. Lend money to your spouse or child. You can simply lend money to your spouse or a child for them to invest. In the case of your spouse, all income and capital gains will be attributed back to you, and in the case of minor children, all income (but not capital gains) will face tax in your hands. But second generation income (that is, income on the income) will not be attributed back to you. It makes sense to move the income annually into a separate account so that its growth can be tracked separately from the original loan amount.
2. Lend money to family at interest. This idea is much the same as the one above, except that you can charge interest on the loan to avoid the attribution rules. By charging the prescribed rate of interest (currently just 1 per cent) your family member, not you, will face tax on any income earned. Your family member will have to pay you the interest every year by Jan. 30 for the prior year’s interest charge (if this is overlooked even once, the attribution rules will apply every year going forward). And get this: The current prescribed rate can be locked in indefinitely. So, if you set this loan up before Dec. 31 of this year, the 1-per-cent rate can apply forever. To the extent your family member earns more than 1 per cent on the funds, you’ll effectively split income.
3. Lend or give money to acquire a principal residence. If you help a family member to purchase a home, this will free up the income of that family member for other purposes – such as investing – effectively moving investable assets from your hands to theirs. In addition, if the property appreciates in value, the capital gain could be sheltered using the principal residence exemption of your family member if they are older than 18 or married.
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Tuesday, November 9, 2010
Example of how you can save $26,000 or more in taxes if you use a Family Trust
Example of the Operation of A Family Trust
Scenario 1: Income Splitting
Mr. X establishes a trust for the benefit of himself, his spouse, Mrs. X, and their three children, A, B and C. A and B are over 18 years of age and attending university. C is a minor living at home.
The participating shares of Opco, Mr. X’s active business corporation, are owned 100% by the trust.
After salaries are paid to Mr. X, Opco is earning $100,000 before tax and $82,000 after tax.
Based on current tax rates, if Mr. X wishes to pay out the net after corporate tax income of $82,000 to himself to enable him to use it personally, he would pay additional taxes of over $26,000 if he were the sole shareholder of the company.
Using the family trust arrangement and paying the income earned by the trust equally to the adult beneficiaries (except Mr. X.), the trust’s dividend could be split evenly between Mrs. X, A, and B. The tax liability on the dividend would thus be taxed as follows:
Mr. X = O in dividend (he is paid via salary)
Mrs. X, A and B all take a Dividend of $27,334 each for a total of $82,000. Hence, if Mrs. X, A, and B have no other sources of income, they would pay no taxes at all on this amount.
Note, that dividends allocated to the minor child would be subject to tax at top marginal rates with no personal tax credits applicable, pursuant to the “Kiddie Tax” provisions.
By using a family trust arrangement, Mr. X has just saved the family unit about $26,000 in tax.
Scenario 2: Capital Gains Splitting
Mr. X has received an offer to sell the shares of Opco (which are "qualified small business corporation shares") for $2,000,000. The shares were acquired for a nominal amount ($100). If Mr. X were to receive the sale proceeds as sole shareholder of the business, his tax liability might be computed as follows:
Proceeds $ 2,000,000
Cost (100)
Capital Gain 1,999,900
Capital Gains Exemption (750,000)
Capital Gains Subject to Tax $ 1,240,900
Taxable Capital Gain $ 620,450
Tax $ 310,225
Under the family trust arrangement, the trust would receive the total $2,000,000 proceeds. The trust's capital gain could be paid out to trust's beneficiaries (if desired by the trustee) and the beneficiaries could shelter the gain with their own $750,000 capital gains exemptions. In this case up to the entire $310,225 in tax calculated above could potentially be saved (subject to alternative minimum tax
considerations).
Note that this benefit can be achieved even if the beneficiary is a minor child, since the "Kiddie Tax" does not apply to capital gains.
Any trust income not actually paid or payable to a specific beneficiary in a given year would be taxable in the trust at the highest marginal tax bracket (thus eliminating the benefits of using the trust).
Amounts will be paid or payable to a beneficiary in the year under the following scenarios:
1. An expense report detailing the year’s expenses incurred by the parent on behalf of a beneficiary is submitted by the parent to the trustee. The trustee initials the report to evidence the exercise of his discretion pursuant to the terms of the trust agreement, and a trust cheque is issued to the parent before the end of the year.
2. The parent requests the trustee in writing to make certain payments to a third party for the benefit of the beneficiary. The trustee initials the written request to evidence the exercise of his discretion and makes the payments to the third party before the end of the year.
3. The trustee declares an income distribution using a trustee’s minute and either issues a trust cheque payable to the beneficiary before the end of the year, or issues a demand promissory note to the beneficiary as evidence of payment before the end of the year.
4. Where the amount of trust income earned is not known in the year (e.g., where a trust owns units in a mutual fund trust) the trustee resolves to make an income distribution to a beneficiary equal to a certain percentage of the undistributed income earned by the trust in the year using a trustee’s minute, and issues a demand promissory note to the beneficiary as evidence of payment before the end of the year.
Under the most recent guidelines released by Canada Revenue Agency, the trust can pay for, or reimburse a wide variety of expenses for a child as long as the payment of the expense clearly benefits the child. Such expenses may include (but are not necessarily limited to):
• Education and tuition expenses
• Recreation expenses and equipment
• The child’s share of restaurant meals and family grocery bills
• Clothing
• Medical and dental expenses
• Spending allowances
• Toys
• Car expenses, including per kilometre reimbursements for driving to and from the child’s activities
• A proportionate share of vacation costs
Asset purchases (e.g., cars, boats, vacation properties) and mortgage payments which cannot or will not be legally registered in a child’s name are problematic and we generally suggest that they not be reimbursed by the trust.
In all cases, receipts should be retained that document the fact that trust funds were spent on the beneficiary’s behalf.
Scenario 1: Income Splitting
Mr. X establishes a trust for the benefit of himself, his spouse, Mrs. X, and their three children, A, B and C. A and B are over 18 years of age and attending university. C is a minor living at home.
The participating shares of Opco, Mr. X’s active business corporation, are owned 100% by the trust.
After salaries are paid to Mr. X, Opco is earning $100,000 before tax and $82,000 after tax.
Based on current tax rates, if Mr. X wishes to pay out the net after corporate tax income of $82,000 to himself to enable him to use it personally, he would pay additional taxes of over $26,000 if he were the sole shareholder of the company.
Using the family trust arrangement and paying the income earned by the trust equally to the adult beneficiaries (except Mr. X.), the trust’s dividend could be split evenly between Mrs. X, A, and B. The tax liability on the dividend would thus be taxed as follows:
Mr. X = O in dividend (he is paid via salary)
Mrs. X, A and B all take a Dividend of $27,334 each for a total of $82,000. Hence, if Mrs. X, A, and B have no other sources of income, they would pay no taxes at all on this amount.
Note, that dividends allocated to the minor child would be subject to tax at top marginal rates with no personal tax credits applicable, pursuant to the “Kiddie Tax” provisions.
By using a family trust arrangement, Mr. X has just saved the family unit about $26,000 in tax.
Scenario 2: Capital Gains Splitting
Mr. X has received an offer to sell the shares of Opco (which are "qualified small business corporation shares") for $2,000,000. The shares were acquired for a nominal amount ($100). If Mr. X were to receive the sale proceeds as sole shareholder of the business, his tax liability might be computed as follows:
Proceeds $ 2,000,000
Cost (100)
Capital Gain 1,999,900
Capital Gains Exemption (750,000)
Capital Gains Subject to Tax $ 1,240,900
Taxable Capital Gain $ 620,450
Tax $ 310,225
Under the family trust arrangement, the trust would receive the total $2,000,000 proceeds. The trust's capital gain could be paid out to trust's beneficiaries (if desired by the trustee) and the beneficiaries could shelter the gain with their own $750,000 capital gains exemptions. In this case up to the entire $310,225 in tax calculated above could potentially be saved (subject to alternative minimum tax
considerations).
Note that this benefit can be achieved even if the beneficiary is a minor child, since the "Kiddie Tax" does not apply to capital gains.
Any trust income not actually paid or payable to a specific beneficiary in a given year would be taxable in the trust at the highest marginal tax bracket (thus eliminating the benefits of using the trust).
Amounts will be paid or payable to a beneficiary in the year under the following scenarios:
1. An expense report detailing the year’s expenses incurred by the parent on behalf of a beneficiary is submitted by the parent to the trustee. The trustee initials the report to evidence the exercise of his discretion pursuant to the terms of the trust agreement, and a trust cheque is issued to the parent before the end of the year.
2. The parent requests the trustee in writing to make certain payments to a third party for the benefit of the beneficiary. The trustee initials the written request to evidence the exercise of his discretion and makes the payments to the third party before the end of the year.
3. The trustee declares an income distribution using a trustee’s minute and either issues a trust cheque payable to the beneficiary before the end of the year, or issues a demand promissory note to the beneficiary as evidence of payment before the end of the year.
4. Where the amount of trust income earned is not known in the year (e.g., where a trust owns units in a mutual fund trust) the trustee resolves to make an income distribution to a beneficiary equal to a certain percentage of the undistributed income earned by the trust in the year using a trustee’s minute, and issues a demand promissory note to the beneficiary as evidence of payment before the end of the year.
Under the most recent guidelines released by Canada Revenue Agency, the trust can pay for, or reimburse a wide variety of expenses for a child as long as the payment of the expense clearly benefits the child. Such expenses may include (but are not necessarily limited to):
• Education and tuition expenses
• Recreation expenses and equipment
• The child’s share of restaurant meals and family grocery bills
• Clothing
• Medical and dental expenses
• Spending allowances
• Toys
• Car expenses, including per kilometre reimbursements for driving to and from the child’s activities
• A proportionate share of vacation costs
Asset purchases (e.g., cars, boats, vacation properties) and mortgage payments which cannot or will not be legally registered in a child’s name are problematic and we generally suggest that they not be reimbursed by the trust.
In all cases, receipts should be retained that document the fact that trust funds were spent on the beneficiary’s behalf.
Monday, November 8, 2010
Business owners: What is a business lawyer ?
What is a business lawyer?
A "business lawyer" or a "corporate lawyer" generally refers to a lawyer who primarily works for corporations and represents business entities of all types. These include sole proprietorships, corporations, associations, joint venture and partnerships. Typically business lawyers also represent individuals who act in a business capacity (owners-managers, entrepreneurs, directors, officers, controlling shareholders, etc.). Further, business lawyers also represent other individuals in their dealings with business entities (e.g. contractors, subcontractors, consultants, minority shareholders, employees). Generally, when I use the term "business lawyer" I think of all three of the above.
What types of clients do I represent?
On a daily basis, I represent start ups, family businesses, owners/managers and mid size companies at the regional, provincial, national and international level in a wide range of industries and I advise clients on their legal issue and their day-to-day business issues, including but not limited to: contracts, corporate structure, mergers & acquisitions, corporate reorganizations (family trust, holding company etc.), estate planning and any other corporate matters. Further, my primay focus is on the creation of various tax-effective structures for the preservation, accumulation and transfer of wealth for entrepreneurs.
Do I need a business lawyer?
If you are a business owner and you are concerned with the legal protection of your business and your personal assets, the answer is YES.
A business lawyer can advise you of the applicable laws and help you comply with them.
A business lawyer can help steer you away from future disputes and lawsuits.
A business lawyer can help protect your tangible and intangible assets.
A business lawyer can help you negotiate more favourable business transactions.
Having a business lawyer can also project positively on your business. Further, an established relationship with a business lawyer can be invaluable when you need to turn to someone who knows your business for quick legal guidance.
Over the years, I have realized that many small businesses have genuine concerns about lawyers running up large tabs for unwanted, unnecessary or questionable work. Hence, I am extremely sensitive to that concern and actively work with you to control legal costs. I believe it is in both our interests to discuss the scope of work and the costs involved before I provide any legal services.
You should seek a business lawyer if you or your company are . . .
- Starting a new business; (partnership, sole proprietorship or corporation)
- Issuing shares, stocks, options, warrants or convertible notes;
- Hiring your first employees (i.e. employment agreement);
- Negotiating a new lease;
- Acquiring another business;
- Reorganizing your affairs to save taxes (i.e. family trust, holding company, etc.)
- Transferring your business to you children and/or employee (Section 86 – Estate Freeze)
- Selling your company;
- Succession planning; (estate planning, estate freeze, primary and secondary will, etc.)
- Planning to create and develop new ideas, products and services;
- Seeking to resolve internal disputes. (i.e. shareholders agreement);
- Any other business/legal issues
For any questions on the above, please do not hesitate to send me an email at hugues.boisvert@andrewsrobichaud.com or at +1.613.237.1512 x 255
A "business lawyer" or a "corporate lawyer" generally refers to a lawyer who primarily works for corporations and represents business entities of all types. These include sole proprietorships, corporations, associations, joint venture and partnerships. Typically business lawyers also represent individuals who act in a business capacity (owners-managers, entrepreneurs, directors, officers, controlling shareholders, etc.). Further, business lawyers also represent other individuals in their dealings with business entities (e.g. contractors, subcontractors, consultants, minority shareholders, employees). Generally, when I use the term "business lawyer" I think of all three of the above.
What types of clients do I represent?
On a daily basis, I represent start ups, family businesses, owners/managers and mid size companies at the regional, provincial, national and international level in a wide range of industries and I advise clients on their legal issue and their day-to-day business issues, including but not limited to: contracts, corporate structure, mergers & acquisitions, corporate reorganizations (family trust, holding company etc.), estate planning and any other corporate matters. Further, my primay focus is on the creation of various tax-effective structures for the preservation, accumulation and transfer of wealth for entrepreneurs.
Do I need a business lawyer?
If you are a business owner and you are concerned with the legal protection of your business and your personal assets, the answer is YES.
A business lawyer can advise you of the applicable laws and help you comply with them.
A business lawyer can help steer you away from future disputes and lawsuits.
A business lawyer can help protect your tangible and intangible assets.
A business lawyer can help you negotiate more favourable business transactions.
Having a business lawyer can also project positively on your business. Further, an established relationship with a business lawyer can be invaluable when you need to turn to someone who knows your business for quick legal guidance.
Over the years, I have realized that many small businesses have genuine concerns about lawyers running up large tabs for unwanted, unnecessary or questionable work. Hence, I am extremely sensitive to that concern and actively work with you to control legal costs. I believe it is in both our interests to discuss the scope of work and the costs involved before I provide any legal services.
You should seek a business lawyer if you or your company are . . .
- Starting a new business; (partnership, sole proprietorship or corporation)
- Issuing shares, stocks, options, warrants or convertible notes;
- Hiring your first employees (i.e. employment agreement);
- Negotiating a new lease;
- Acquiring another business;
- Reorganizing your affairs to save taxes (i.e. family trust, holding company, etc.)
- Transferring your business to you children and/or employee (Section 86 – Estate Freeze)
- Selling your company;
- Succession planning; (estate planning, estate freeze, primary and secondary will, etc.)
- Planning to create and develop new ideas, products and services;
- Seeking to resolve internal disputes. (i.e. shareholders agreement);
- Any other business/legal issues
For any questions on the above, please do not hesitate to send me an email at hugues.boisvert@andrewsrobichaud.com or at +1.613.237.1512 x 255
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