Tax planning for business owners june 2014 Sean Rheubottom - United Financial

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Presentation to the Estate Planning Council of Abbotsford

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  • Could you have the kind of investment portfolio you personally like, but structure it in a way that minimizes tax?
    Can you benefit from your investment strategy but minimize the tax slips that show up every year?
    The answer is yes, you can do that. Your Assante advisor knows how to structure a non-registered portfolio so that it:
    - “converts” [or whatever language you choose to use here]
    - defers
    - has ability to switch
    And with investments held in your holding corporation, you can use this tax deferral structure in your investments to address some unique problems corporations have when it comes to investment income:
    - with a portfolio that produces dividend income, there is a kind of “refundable tax” that your corporation has to pay which increases the tax burden – you can defer this
    - [in some provinces] there is a higher tax rate in interest income if it flows to you thru a corporation – again you can defer this.
    Tax people get pretty excited when they learn about this, they [we] really like it. Ask your financial advisor how to do this – Assante advisors are in the unique position of being able to do this better than anyone in the industry. Ask them about their “Corporate Class” portfolios.
  • Could you have the kind of investment portfolio you personally like, but structure it in a way that minimizes tax?
    Can you benefit from your investment strategy but minimize the tax slips that show up every year?
    The answer is yes, you can do that. Your Assante advisor knows how to structure a non-registered portfolio so that it:
    - “converts” [or whatever language you choose to use here]
    - defers
    - has ability to switch
    And with investments held in your holding corporation, you can use this tax deferral structure in your investments to address some unique problems corporations have when it comes to investment income:
    - with a portfolio that produces dividend income, there is a kind of “refundable tax” that your corporation has to pay which increases the tax burden – you can defer this
    - [in some provinces] there is a higher tax rate in interest income if it flows to you thru a corporation – again you can defer this.
    Tax people get pretty excited when they learn about this, they [we] really like it. Ask your financial advisor how to do this – Assante advisors are in the unique position of being able to do this better than anyone in the industry. Ask them about their “Corporate Class” portfolios.
  • Example:
    Client leaves $500,000 in trust for her 2 grandchildren
    The trust earns $20,000 of investment income in a year
    The investment income is used equally for each grandchild’s education expenses
    $10,000 is reported as income by each grandchild. They have no other income.
    No tax would be payable.
    Note that basic personal exemption in BC will increase to $11,000 in 2010.
    If investment income was retained in the trust, tax payable would be approximately 4,200.
    If the parent of the grandchild had received the inheritance outright and was at the high rate, the parent would have paid $8,740 in tax on investment income of $20,000
    Because amounts paid may be treated as the children’s income, the trust structure results in significant tax savings
    Keep proper records and receipts.
  • Tax planning for business owners june 2014 Sean Rheubottom - United Financial

    1. 1. Sean Rheubottom, B.A., LL.B, TEP Regional Vice President, Wealth Planning United Financial, a division of CI Private Counsel LP Tax Planning for Business Owners: wealth planning overview Abbotsford June, 2014
    2. 2. Corporate and personal tax rates and tax saving opportunities
    3. 3. Taxation and integration of corporate and personal income Interest, Salary, Business Income Capital Gains Dividends (Non-Eligible) Dividends (Eligible) 43.7% 45.8% 21.85% 22.9% 33.71% 37.99% 25.78% 28.68% Active business income < $500K Active business income > $500K Interest, Rent (passive) Capital Gains Portfolio Dividends 13.5% 26% 45.67% 50% taxable, as interest 33.33% Increased from 25% in April 2013 - Increased from 44.67% in April 2013 - Taxable income subject to 26.67% refundable tax (so 19% permanent tax) Refunded on payment of dividend Corporate tax rates in BC 2013 and 2014 Personal tax rates in BC 2013 / 2014 (top rates) Integration in BC 2013 / 2014: cost or saving Active business income < $500K Active business income > $500K Interest, Rent (passive) Capital Gains Portfolio Dividends 1.04% 0.58% 1.38% 1.42% 2.61% 3.97% 1.3% 1.99% Neutral
    4. 4. Tax deferral  Active business income below $500K:  Personal rate if paid as salary: 45.8% of $500K =$229,000  Corporate rate if retained: 13.5% of $500K =$ 67,500  Maximum tax deferral in one year: 32.3% of $500K =$161,500  Active business income above $500K:  Personal rate if paid as salary: 45.8%  Corporate rate if retained: 26%  Maximum tax deferral in one year: 19.8%  Interest or rent (passive) income:  Personal rate if earned personally: 45.8%  Corporate rate if earned corporately: 45.67% (26.67% refundable) 0.13% no deferral
    5. 5. Power of a tax deferral (using 43.7% personal tax rate) $500,000 business income in Year 1… 5 years to save, then spend it 1. Pay out to shareholder as salary / bonus (or if no corporation)  After 43.7% tax, $281,500 remains  Invest $281,500 for 5 years at 5%  $359,273  Liquidate account after year 5, pay tax on the capital gain Available to spend after tax, after 5 years: $342,280
    6. 6. $500,000 business income in Year 1… 5 years to save, then spend it 1. Pay out to shareholder as salary / bonus (or if no corporation)  After 43.7% tax, $281,500 remains  Invest $281,500 for 5 years at 5%  $359,273  Liquidate account after year 5, pay tax on the capital gain Available to spend after tax, after 5 years: $342,280 2. Retain in corporation for 5 years  After 13.5% corporate tax, $432,500 remains  Retain / invest $432,500 for 5 years at 5%  $551,992  Liquidate account after 5 years and pay all cash out to individual  Corp realizes and pays tax on the capital gain  Individual pays tax on cash extracted as non-eligible dividend and capital dividend Available to spend after tax, after 5 years: $378,531 Tax deferral results in absolute tax savings. Power of a tax deferral (using 43.7% personal tax rate)
    7. 7. Accessing the capital gains exemption
    8. 8. 8  $800,000 lifetime capital gains exemption on the disposition of QSBC shares  What is a QSBC share?  Share of a CCPC  90% asset test  50% asset test (24 months) Excess cash / investments don’t qualify  24-month ownership test  shares newly issued are deemed not owned by related person Capital Gains Exemption (“CGE”): “Qualified Small Business Corporation” (“QSBC”) Shares
    9. 9. 9 Problem: Shares do not qualify for the CGE OpcoOpco Jack 100% Total value: $3,000,000  Jack’s business is successful – Owns $1 mil cash / investments – retaining more each year – When sold (or at death), will not meet 90% test - all gains would be taxable – Tax at 22.9%: $687,000 Operations $2,000,000 Cash & investments $1,000,000
    10. 10. 10 “Purify”: Move passive assets out of Opco Problem: removing assets from a corporation causes tax  capital gains to corporation  taxable dividends to shareholder Simple or complex methods  Repay s/h loans  Use available tax accounts  Non-arm’s length butterfly  Safe income strip Purification
    11. 11. 11 Capital gains exemption: “Butterfly” type purification  Transfer passive assets to Investco without triggering gains  Very common planning  Complex rules apply; potential negative tax consequences  Experienced advice is important OpcoOpco Jack 100% InvestCoInvestCo 100% Cash & investments $1,000,000 Operations $2,000,000
    12. 12. 12 Capital gains exemption and purification: Purify sooner, not later Purify sooner rather than later! 24-month 50% test to qualify for capital gains exemption ITA 55(2) anti-avoidance rule - may apply with very negative effect where “butterfly” done in contemplation of sale  “Safe income” dividends may shelter from 55(2)  Simpler to purify early and on ongoing basis
    13. 13. 13 Jack’s shares will qualify for the $800,000 capital gains exemption Dividends flow tax-free to InvestCo  Preserves deferral of small business rate Simple example of advance sale preparation Can add a freeze to this structure Ongoing purification – simple structure Dividends InvestCoInvestCo Jack OpcoOpco 100% common shares
    14. 14. 14 Protection against potential future creditors Secured loan back to Opco Use InvestCo for creditor protection InvestCoInvestCo Jack OpcoOpco 100% common shares Loan
    15. 15. Investment Holdco Issues
    16. 16. Investment holdco issues: “Corporate attribution” • Express exceptions • “SBC” 90% test • 74.4(4) trust • CRA administrative exception • “pro rata” transfer exception • Advance planning to avoid it • Stock dividend freeze • “Drop down” freeze • Must be considered in cases where asset sale is anticipated • Incorporated professionals need to plan around it InvestCo Mr. A Freeze and issue shares to spouse, children, or to a trust for them?
    17. 17. 17 Investment income of a private corporation: Integration failure Extra cost of earning interest income through a private corporation:  2.61% in BC in 2013  3.97% in BC n 2014 Can we avoid or defer this extra cost?  Seek a portfolio structure that defers taxable distributions Extra cost of realizing capital gains in a private corporation:  1.3% in BC in 2013  1.99% in BC in 2014  Can we avoid or defer this extra cost?  Seek a portfolio structure that defers taxable distributions
    18. 18. 18 Portfolio dividends received by a private corporation  InvestCo receives portfolio dividend (eligible dividend)  InvestCo pays Part IV tax at 33% - to RDTOH of InvestCo  InvestCo can pay eligible dividend to Mr. A  refund of RDTOH at $1 for every $3 paid (33%)  Mr. A pays 28.68% tax on the eligible dividend  4% tax “win”…  Problem: no chance to defer tax  Can we defer somehow?  Seek a portfolio structure that defers taxable distributions  defer Part IV tax and dividend tax Jack Opco InvestCo Part IV tax 33% Portfolio dividends (eligible dividends)
    19. 19. Tax-preferred income: dividends and capital gains  even if portfolio includes exposure to interest, foreign income  increase your after-tax income Defer income by minimizing distributions (tax slips)  deferral of tax results in absolute savings over time Switch or “rebalance” investment strategy without incurring tax Tax-efficient retirement cash flow  Trigger capital gains rather than interest income  Works well with a corporate account Investment income (corporate or individual) Consider tax aspects
    20. 20. Corporate “freeze” structure
    21. 21. Our Financial Analysis confirmed that Jack and wife Sheila are financially “more than sufficient” Is there a better way to:  split income with spouse and pay for children’s expenses?  minimize the tax in the event of sale or death? Corporate freeze structure
    22. 22. BC Family Law Act and discretionary trusts: a welcome update OLD (March 18 2013) Section 85 “excluded property”: …(f) property held in a discretionary trust…of which the spouse is a beneficiary But: Susec 84(2) : Family property includes: …(g) the amount by which the value of excluded property has increased [during the spousal relationship] NEW (in force May 26 2014) Section 85 “excluded property”: …(f) a spouse's beneficial interest in property held in a discretionary trust…  Appears we are back to valuing an interest in a discretionary trust  difficult to value!
    23. 23. 23 Corporate freeze structure InvestCoInvestCo Jack OpcoOpco 100% preference shares $2,000,000 Beneficiaries: Jack, spouse, children, future grandchildren, corporation Family Trust Family Trust 100% common shares $100  Jack does not give up control (voting p/s)  Growth accrues to Family Trust  Income splitting through Family Trust  Shares held by Trust can roll to child  If Jack retires, switch from salary/bonus to dividends – redeem shares 100% common shares Reversible freeze Potential “tax free” dividends in BC in 2014: Cash eligible dividends: $49,289 Cash non-eligible dividends: $22,289
    24. 24. 24 Corporate freeze structure InvestCoInvestCo Jack OpcoOpco 100% preference shares $2,000,000 Beneficiaries: Jack, spouse, children, grandchildren corporation Family Trust Family Trust 100% common shares $100 Caution: corporate attribution Solution: maintain “purity” of Opco
    25. 25. 25 A better freeze structure InvestCoInvestCo Jack OpcoOpco 100% preference shares $2,000,000 Beneficiaries: Jack, spouse, children, grandchildren corporation Family Trust Family Trust 100% common shares $100  InvestCo as beneficiary of Family Trust  InvestCo may also be frozen to the Family Trust  assuming no prior contaminating transfer to InvestCo for corporate attribution purposes
    26. 26. 26 After the freeze – redemption program for freeze shares Jack OpcoOpco 100% preference shares $2,000,000 Beneficiaries: Jack, spouse, children, grandchildren corporation Family Trust Family Trust 100% common shares $100  Jack’s freeze shares may be redeemed over time  Redemption payments are deemed dividends  Determine redemptions annually based on other income and tax  Achieve income smoothing over time  Reduce capital gain at death
    27. 27. 27 Accessing multiple capital gains exemptions $800,000 CGE x 4 $3,200,000 in capital gains sheltered from tax $699,200 potential tax saving (using 21.85% tax rate) Timing of freeze less than optimal? $800K CGE $800K CGE $800K CGE $800K CGE Family Trust Family Trust OpcoOpco Preference shares $2,000,000 100% common shares child Sheila Jack child
    28. 28. Shareholders’ agreements; Death buy-sell; Post-mortem planning
    29. 29. Share purchase v. Share redemptionFor succession planning or arm’s length death buy-sell Corporately-held insurance  Share redemption strategy to extent insurance is available  Share purchase for value in excess of insurance  Liquidation of deceased’s shares: spousal “roll and redeem” strategy to avoid stop loss rules  A tax-free buy-out? Use of life insurance in post mortem planning OpcoOpco XX JackJack X HcoX Hco J HcoJ Hco FTFT
    30. 30. Will planning: Tax saving using trusts despite high flat-rate tax?
    31. 31. Testamentary Trusts: Income Splitting with Low Rate Beneficiaries  $1,000,000 in trust for your adult Daughter (high income earner) and her 3 young children  investments produce $50,000 income  each child requires $10,000 per year for education expenses = $30,000  children have no other income  Tax the remaining $20,000 in the trust  Tax each child pays: $10,000 x 0% = $ 0 tax $10,000 x 0% = $ 0 tax $10,000 x 0% = $ 0 tax  Tax the trust pays: $20,000 x 45.8% = $ 9,160 tax  Compare tax to Daughter on $50,000 with no trust: $50,000 x 45.8% = $22,900 Annual tax saving: $13,740  Alter-Ego and Joint Partner Trusts – achieve the above while avoiding probate fees TrustTrust Her childHer child Her childHer child Her childHer child Pay children’s expenses out of trust income Adult daughter
    32. 32. This material is general in nature and subject to change without notice. Every effort has been made to compile the information from reliable sources, however no warranty can be made as to its accuracy or completeness. The information provided within this presentation is for illustrative purposes only. Before acting on any of the information contained herein, please seek professional advice based on your personal circumstances. Assante is an indirect, wholly-owned subsidiary of CI Financial Corp. (“CI”). The principal business of CI is the management, marketing, distribution and administration of mutual funds, segregated funds and other fee-earning investment products for Canadian investors through its wholly-owned subsidiary CI Investments Inc. If you invest in CI products, CI will, through its ownership of subsidiaries, earn ongoing asset management fees in accordance with applicable prospectus or other offering documents. Paid for in part by United Financial, a division of CI Private Counsel LP. © 2014 United Financial, a division of CI Private Counsel LP. All rights reserved. Thank you

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