Accountants are busy crunching the numbers for small-business clients who may be affected by Ottawa's proposals to close loopholes these companies use to lower their tax bills.
The Liberal government is looking to remove what it sees as a financial advantage people with corporations have compared with salaried employees. Business owners argue the suggested moves are unfair and could have wide-sweeping consequences on their ability to expand their businesses, not to mention their own retirement goals.
The Globe and Mail asked financial experts to provide before-and-after scenarios of three of Ottawa's proposed changes, including using corporations for so-called "income sprinkling" among family members; reducing the lifetime capital-gains allowance for a family; and so-called "passive" investment income, where a business owner invests money they don't need right away in their corporation, at a lower tax rate, instead of taking it out as personal income, at a higher tax rate, and investing it.
These scenarios are examples and investors and business owners are encouraged to consult a tax professional for more information about how Ottawa's proposed changes could affect them.
The government is looking to restrict the ability of business owners to reduce their taxes by sprinkling income among adult children in lower tax brackets through salary or wages, or through dividends, which are taxed at a lower rate. Ross McShane, vice-president of financial planning at Doherty & Associates in Ottawa, looked at the impact of a business owner not being able to pay a dividend to a child for their education and, instead, having to take the draw as their own income (in a higher tax bracket).
He uses the example of an Ontario doctor who draws a salary from her corporation of $55,300 (allowing her to maximize CPP contributions) and a dividend of $50,000, for a total income of $105,300. The tax paid here is $22,055.
Assuming she pays a $40,000 dividend to her 20-year-old son, who is attending university, the dividend is essentially tax-free.
If the doctor can't sprinkle that income to her son and has to report the $40,000 dividend as her income, the tax on it is about $14,000 (or 35 per cent). As a result, the family nets $26,000, instead of $40,000 available for education costs.
If you have more than one child going to college or university, the difference can really add up, he says. "If their priority is still to cover the expenses for the children, they'll be working with a lot less in their pocket after tax," Mr. McShane says.
Lifetime Capital Gains
Many business owners with families have taken advantage of the lifetime capital gains exemption (LCGE) when they sell the business. The amount that can be sheltered rises with inflation and is $835,716 in 2017. Tax planners have set up structures where family members become shareholders in the company, even if they haven't directly contributed to the business. The government is proposing to crack down on this, to allow just one family member to receive the credit.
Jamie Golombek, managing director of tax and estate planning at CIBC Wealth Strategies Group, looked at the before and after scenarios for a family of four – each with equal shares in the company – that sells a business with a total capital gain of $4-million. His example assumes the top marginal tax rate in Ontario.
In the current system, each shareholder could be eligible for the LCGE of $835,716, which is a total of about $3.3-million that isn't taxed. The gain is $657,000 and the total tax paid would be $176,000, or at a capital gain rate of 26.8 per cent.
Under the proposed new system, only one shareholder in the family would receive the LCGE. The gain would be $3.2-million and the tax paid on that would be about $847,000. That means the government would receive an extra $671,000 in taxes on the sale of the company.
"In the old case, you get four times the exemption, in the new case you get one exemption," Mr. Golombek says. "Put another way, the lost opportunity would cost three times the amount."
To look at the implications of changes to passive income, Aaron Schechter, a Toronto-based tax partner at Crowe Soberman, used the example of an incorporated business in Ontario that generates $220,000 a year. The business owner takes an annual salary of $144,277 and sets aside $100,000 for personal living expenses for themselves and their family.
After 30 years, with a 7-per-cent rate of return, and assuming the business earns the same, takes the same salary and pays the same CPP, the owner will have a little more than $2.2-million in investment income once they take the money out of the corporation.
Under the proposed new system, which adds another level of tax on the investment income earned in the corporation (or an extra 30.7 per cent), the business owner would have $1.7-million in investment income once they take the money out of the corporation.