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Impact of tax changes on small businesses greater than you think

At last week's Liberal caucus retreat in Kelowna, B.C., Prime Minister Justin Trudeau stated that the tax rules applying to private corporations need "tweaking." He also said that proposed tax changes introduced on July 18 are aimed at those earning more than $150,000 annually. Here's the reality: Talk to any tax professional and you'll understand that these proposals represent perhaps the most significant overhaul to our tax law that we've seen since 1972. Tweaking? Hardly.

As for impacting the wealthy only: I want to share the story of a middle-class business owner who will be significantly affected by these changes. I want to thank Tim Miron, CPA, CA, an accountant with the firm Beckett Lowden Read in Burlington, Ont., for this example of how the proposed tax changes will impact many middle-class families.

Read more: Accountants, financial planners brace for hit from tax changes (for subscribers)

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Explainer: What Canada's new tax-planning proposals mean for private businesses

Read more: How much will Morneau's proposed tax changes cost small business? We do the math (for subscribers)

The story

Sally (not her real name) is a single mother of two. She owns and operates a small business through a private corporation and employs five staff who all earn between $40,000 and $50,000 annually. After paying her staff and operating expenses, Sally is left with income of $80,000 before taxes in a typical year. In the past, Sally has split income with her oldest son, Chris, who is 20 years old and attends college part-time, by paying Chris dividends from the company. While our current tax law doesn't allow this type of income splitting for those under 18 (a special tax called the "kiddie tax" applies), it's allowed for adult children.

If the Liberal tax proposals are enacted, Sally won't be able to split income with Chris any longer. This will cost the family an additional $6,100 in income taxes annually. Some might say "tough luck, Sally" – business owners shouldn't be able to split income when employees can't. The fact, however, is that Sally has disadvantages that employees don't (she can't claim Employment Insurance benefits, doesn't get paid vacation time, doesn't have the same protection of employment laws, has exposed her personal assets as collateral to provide cash for the business, is the last one to get paid if cash is tight, etc.).

It's also worth noting that an additional $6,100 in taxes owing represents a 40-per cent increase in taxes payable. That's a huge difference for Sally. She's not wealthy and spends most of what she earns. She doesn't have an additional $6,100 that she can cut out of her personal budget. Since her business is her only source of income, she needs to find that additional $6,100 after taxes from her business somehow.

The plan

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In order for Sally's business to provide her with an additional $6,100 after taxes each year, it needs to pay her an additional $9,000 before taxes annually. The bottom line? She needs to cut business expenses by about $9,000 annually to do this. After giving this thought, here's the list of things Sally is considering, to achieve these cost savings:

  • No raises for her (middle-class) employees (a 2 per cent raise each year normally costs her $4,000 plus employment taxes);
  • A reduction in company benefits for her (middle-class) employees;
  • Moving her office farther out of the city where she and her staff live, where rent is cheaper, which will increase travel time and costs for all (middle-class) staff;
  • Cancelling her sponsorship of a local festival attended by many residents of that city;
  • Reducing the donations she makes to local charities, including the local food bank;
  • Eliminating her business coaching (which provides income to her coach – another middle-class entrepreneur, and which led to business growth and resulted in the hiring of her last employee);
  • Cancelling her twice-per-winter family ski trips to Collingwood to save a little more.

The moral

Is it really a big deal if Sally cuts back her donations, or trips to Collingwood each year? Sally alone may not make a big difference in the life of those charities, restaurants, resorts, etc. But imagine the larger impact if every small business owner in the country has to make these types of decisions. In the end, Sally will likely have to make some small changes to her life to make ends meet, but perhaps the biggest impact will be for those other middle-class people in her life.

Mr. Trudeau says the proposed tax changes will only impact the wealthy. He's either disingenuous or doesn't understand the proposals his government announced on July 18. Neither of these is acceptable for our Prime Minister – or his Finance Minister. The answer? Abandon the proposals, clearly define and make public the desired policy objectives, then consult with professionals, business owners and Canadians at large on how to change our tax law in appropriate ways.

Tim Cestnick, FCPA, FCA, CPA(IL), CFP, TEP, is an author and founder of WaterStreet Family Offices.

Video: Money Monitor: Tax benefits of giving money to heirs while alive (The Canadian Press)
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About the Author
Author and founder of WaterStreet Family Offices

Tim Cestnick, FCPA, FCA, CPA(IL), CFP, TEP, is an author and founder of WaterStreet Family Offices. More

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