Legend / AssumptionsCRA = Currency raking associates or Canada RevenueAgency.All examples assume we use the top tax rates:15% corporate income tax46% salary tax rateThis information is for discussion purposes. Please speak to a tax professional for yourspecific planning.
1) Effective Tax Planning• Incorporation• Holding companies• Retirement (Holding company vs RRSP)• Life insurance• SRED Credits and wages
IncorporationAssumptions: Extra income $20,000 Unincorporated Income ofTax 46% Income $120,000 living off of $100,000. $9,200 Net after tax cash $10,800
IncorporationIncome earned in a corporation. Owner paid $100,000 salary. Corporate income $20,000 Additional Costs $2,000 Net income $18,000 15% Income Tax $2,800 Net after tax cash $15,200 34% Tax on Dividends $5,200 After Tax Cash $10,000
Incorporation Unincorporated after-tax cash $10,800Tax savings on incorporation: Incorporated after-tax cash $10,000 Tax savings $-800This example assumes two things: 1) All the income is earned at the top tax rates 2) The income is all taken out in the same year
IncorporationA corporation is effective in tax planning if: The income is taken at lower tax rates. The income is not taken out each year (more earnings retained for investment)
Compounding effect of incorporationUnincorporated IncorporatedAfter Tax Cash $10,800 After Tax Cash $15,200Invested for 20 years Invested for 20 yearsRate of return 5% Rate of return 5%(before taxes) (before corp taxes)Value $289,100 Value $484,300Annual draw $30,000 Annual draw $30,000Years to draw 9.5 Years to draw 16
Holding CompaniesDividends between related companies can be paid tax free.A holding company is a corporation in place to hold the sharesand / or non-operating assets of a corporate group.In a business with multiple families involved, family holdingcompanies can be put in place to allow for a saver and aspender.Capital gains exemptions can be compromised with Hold Cos.
Retirement - RRSP vs CorporationRRSPs provide for a deduction in income equal to thecontribution made.When the income comes out it is taxed at the marginal rates.$20,000 could be at a rate of 35% = $7,000 in tax in retirement.RRSPs are limited to 18% of earned income or $21,000 / year
Retirement - RRSP vs CorporationRetained earnings in the company can build up over time.Retained earnings are already taxed at the corporate rate.If no other income $35,000 / year can be paid for virtually nopersonal income tax.Retained Earnings are not limited.
Incorporation vs RRSPUnincorporated IncorporatedCash $20,000 After Tax Cash $15,200Invested for 20 years Invested for 20 yearsRate of return 5% Rate of return 5%(no taxes) (before corporate taxes)Value $694,385 Value $484,300Taxes on withdrawal 35%After Tax Cash $451,000Annual draw $30,000 Annual draw $30,000Years to draw 15 Years to draw 16
Incorporation vs RRSPPros and Cons • Dividends can be split between any shareholders • RRSPs have contribution limits where retained earnings do not. • RRSPs have required withdrawals (RIF) • RRSP income is all taxed at the same rate as interest (the high rate)
Life InsuranceUses for life insurance:• Catastrophic event protection• Estate Planning• Expedited savings
Life Insurance - ProtectionIn a business with 2 or more families involved, life insurancecan be used to protect the families of the shareholders.If the life insurance premiums are deducted on the tax returnthe proceeds flow-into the company tax free.A capital dividend account then allows for a tax-free paymentout of the company to buy-out the estate of the former partner.
Life Insurance - Estate PlanningLife insurance can be used:• To pay the realized gains on death• Equalization between children in / out of the business o One child could inherit the business o The other child could inherit the life insurance policy
Life Insurance - Estate PlanningYou could also purchase an insurance policy and list me as thebeneficiary! Im worth it I promise!
Life Insurance - Expedited savingsIn certain life insurance arrangements (Universal / Whole Life)a company can contribute investment dollars to an insurancepolicy.The contributions would grow inside the insurance policy taxfree (increasing the compounding).The Cash Surrender value of the policy can either bewithdrawn (some tax consequences) or borrowed against, to bepaid off when the policy pays out.Do NOT sign up for this without speaking to your accountant!
SRED CreditsScientific Research and Experimental Development credits areavailable on a wide variety of development projects.A credit is received for costs incurred to perform SRED work.One cost is wages of specific employees. The max is 5 timesthe CPP max ($48,000). However bonuses are not included inthese wages.
2) Income Splitting• Reduce taxes• Family Trusts• Multiplying tax savings
Income Splitting - Reducing Taxes Income splitting only works if you have someone to split the income with.
Income Splitting - Reducing TaxesIdeally - Income between spouses is the sameIn a corporation only three ways for an individual to be paid:• Salary• Dividends• Interest / Rent
Income Splitting - SalaryCRA requires that salaries paid to related individuals must be afair wage for services performed.• Have a job description• Have other staff know who your spouse is• Have your spouse know where the office is• Pay them on the regular payroll (not a one time bonus)• Pay them as an employee not a sub-contractor
Income Splitting - DividendsDividends are paid to a class of shares of the company out ofafter tax earnings.• Set up different classes of shares allowing discretionary dividends• Do not pay dividends to individuals under 18• Shares do not have to be voting• Shares either have a fixed value (cap on dividends) or grow with the value of the company
Income Splitting - PropertyA company can pay rent / interest to an individual• Rent between related parties must be at fair value• Interest must be at market rates and on an amount loaned to the company
Income Splitting - Family Trusts If you cant trust family who can you trust?
Income Splitting - Family TrustsShares of a company can be owned by another corporation, anindividual or a family trust.A family trust is a legal entity that can hold capital items andreceive income. The income must either be paid out toindividuals and taxed personally or the tax is paid by the trust.The trust can be set up to discretionally pay income out (notconsistent basis).At the end of an inter-vivos trusts life (21yrs) the capital mustbe paid out.
Income Splitting - Family TrustsExample: • A family trust could be created to hold a class of shares of the company.• The beneficiaries could include you and your children• The corporation could pay dividends to the trust• The trust could then allocate those dividends to a child in university.• $30,000 after tax is $35,300 in income• $30,000 personally would require $55,500 in personal income.
Income Splitting - Multiply Tax SavingsMultiple small business deductions• Set up two separate corporations earning active income, one owned by two separate people.• This would create 2 small business deductions• Association rules would have to be carefully considered• Up to date and on-going sets of books would have to be maintained.
Income Splitting - Multiply Tax SavingsCapital Gains Exemption (CGE):• Every Canadian is entitled to one life time capital gains exemption of $750,000 on the sale of a business or shares in a business• Having multiple common share holders could allow for this exemption to be used by more individuals• Using a family trust with children over 18 as beneficiaries could result in many CGEs
Income Splitting - Multiply Tax SavingsCapital Gains Exemption (CGE):• If you need one more $750,000 exemption, I have not used mine yet.• Im just saying . . . .
3) Hybrid Expenses• Home Office• Automobile expenses• Cell phones• Medical expenses
Home Office ExpensesIf you do not have an external office or you regularly meetclients at your home, you can deduct a percentage of the costsof your home (include HST).Including: • mortgage interest • utilities, heat, hydro, gas, water, internet, phone • insurance • property taxes • RepairsDo not include capital improvements or you could ruin theprincipal residence exemption.
Automobile ExpensesCompany owned vehicle:• Must calculate personal portion (keep all receipts)• Taxable benefit does not decrease as the value of the vehicle does.• Calculations are messyPersonally owned vehicle: • The driver charges the company mileage. • Only need to keep log of company driving • Tax deductible expense not taxable to driver.
Hybrid ExpensesCell phones• Have the cell phone billed to the company• Charge back the owner for personal phone callsMedical Expenses• Medical insurance is deductible to the company but not taxable to the employee• Life and LTD insurance are taxable benefits and better paid by the employee (or owned by the company).• Consider a Health and Welfare Trust
4) Sales Tax Savings• Common pitfalls o HST on meals o HST on mileage o Place of supply rules• Restricted ITCs o HST of vehicle purchases o HST for large companies
Sales Tax BasicsAny business with over $30,000 in sales in any one year isrequired to register for HST.The HST collected on sales is offset by the HST paid onpurchases. The net amount is paid or refunded.Register early, to claim ITCs on your start-up expenses.There is a quick method for companies with sales under$200,000.
Sales Tax - Meals Meals are only 50% deductible for income tax purposes. The CRA says you needed to eat any ways. Under the same thinking the HST paid on meals is only 50% deductible. Extra Tip: Every business is allowed to fully deduct 6 meals a year as long as all of the staff are invited (ie. Holiday Party, Company BBQ, Throwing Tim a Birthday Party!)
Sales Tax - Mileage HST registered companies paying mileage should also pay HST on top of the mileage rate ($0.52 + HST). This is an extra 13% in the individuals pocket that is refundable to the company. For every 2,000km that is an extra $135! WIN WIN! If the company pays auto expenses and a taxable benefit to the individual then HST should be added to the taxable benefit.
Sales Tax - Place of Supply Place of supply rules determine what rate of GST / HST to charge. There are some specific rules. Otherwise the rate to charge is the rate in the province the goods / services are being delivered to. Sales to the US are zero rated (but must be included on HST return).
Sales Tax - Place of Supply Actual General Rule: If a supply of a service is made and, in the normal course of business, the suppler obtains a particular address of the recipient that is (a) a home or business address in Canada of the recipient, (b) where the supplier obtains more than one home or business address in Canada of the recipient, the home or business address that is most closely connected with the supply, or (c) where the supplier does not obtain a home or business address in Canada of the recipient, but obtains another Canadian address that is most closely connected with the supply, the supply will be regarded as made in the province which the particular address is situated.
Restricted ITCs on Autos Passenger vehicles are limited to $30,000 plus tax. HST credit on passenger vehicles is also limited. This limit is not indexed to inflation.
Restricted ITCs on Autos Why do you need such an expensive car?
Restricted ITCs on Autos Thats OK! Tim told me to pay mileage instead!
Restricted ITCs for Large companies For companies with over $10 million in sales some HST ITCs are restricted. The restriction applies to: • Costs related to vehicles under 3,000 kg • Energy for overhead (not in manufacturing) • Telephone, satellite TV but not internet • Meals
Restricted ITCs for Large companies Restriction is currently 100% of provincial portion of HST (8%). Phasing out between July 1, 2015 and 2018 HST returns must show HST paid and HST restricted separately.
Restricted ITCs for Large companies Is there any good news?
Restricted ITCs for Large companies Good News: • Only required for large companies • Large companies can afford to pay their accountant extra to sort it out.
Restricted ITCs for Large companies I actually like this rule!
5) Avoiding Voluntary Taxes• Interest and penalties• Late filing• Filing Thresholds• Employment insurance• Canada Pension Plan• Employer Health Tax• Separate wills
Interest and penaltiesInterest and penalties are non-deductible.Interest is charged at CRA plus 4%.Currently that rate is 5%That is the equivalent of 6% pre-tax interest
Late Filing PenaltiesLate filing penalties are Nasty!
PenaltiesStandard Penalties start at 10% of the tax owing.The percentage can increase (double) for repeat offenders.T4 and T5 penalties are $25 per day up to $2500SRED claims are not allowed if filed 18 months after year end.There is no penalty for filing on time but not paying.
Filing Thresholds - GST Annual Taxable Assigned reporting Optional reporting Supplies period periodIt is the companys responsibility to inform the government of achange in$1,500,000 or less filing frequency. Annual Monthly or Quarterly More than $1,500,000 Quarterly Monthly up to $6,000,000 More than $6,000,000 Monthly Nil
Filing Thresholds - Source DeductionsIt is the companys responsibility to inform the government of achange in filing frequency.AMWA - Average Monthly Withholding Amount< $3,000 = Quarterly *$3,000 - 15,000 = Monthly on the 15th$15000 - 50000 = twice a month$50,000 + = 4 times a monthTo file quarterly you must have 12 months of perfectcompliance history.
Employment InsuranceEmployment insurance is not required on directors / officers ofa corporation.Also exempt are relatives of directors.This could save an employee $800 / year and the company$1,120 per year.Consider paying EI for family that might take a parental leave.
Employment Insurance Why is family exempt from Employment Insurance?
Employment Insurance Because you could not fire them even if you wanted to!
Voluntary Taxes - CPPCannot opt out of CPP.CPP is paid on wages (not dividends)CPP is based on best 85% of years.Consider switching to dividends when near retirement.Saving $4,000 per year.New CPP rules starting in 2012!
Avoiding Voluntary Taxes - EHTEmployer Health Tax is 1.95% on any wages paid in Ontarioover $400,000 (no exemption for owners).Consider paying shareholders not through wages:- Rent- Interest on shareholder loan- Dividends
Voluntary Taxes - Separate WillsProbate is the administrative fee (not a tax) on an estate.$5 per $1,000 on first $50,000$15 per $1,000 afterwardsMost entrepreneurs largest asset is their company.A separate will can exclude your company from probate.
Voluntary Taxes - Separate Wills Quick Someone call a lawyer!