We all like to save tax. But if you are a private business owner, a carefully considered and executed tax strategy is a must-have to protect the financial best interests of your business, your employees, and your family. Here are a few key things to consider when conducting your 2020 year-end tax planning:
Optimize the mix of salaries and dividends for you and your family members
Determine the best mix of salary and dividends for you and your family members by considering factors such as each individual’s marginal tax rate and need for cash, your corporate tax rate, and the benefits of deferral.
If you do not need cash, consider retaining income in the corporation. Tax is deferred if the corporation retains income when its tax rate is less than your personal rate.
Consider paying yourself a tax-free capital dividend if your company has a balance in its Capital Dividend Account (CDA).
Consider paying dividends to adult family members in a lower tax bracket who are shareholders in your company. But be aware of the “tax on split income” (TOSI) rules. When the TOSI rules apply, dividends will be taxed at the highest marginal rate, which eliminates the benefit of income splitting. There are several situations in which you can split income with family members in a tax-efficient manner, but the TOSI rules are quite complex. We recommend that you speak with your accountant or advisor before paying dividends to family members.
TOSI rules don’t apply to salaries, so ensure you pay a reasonable salary to your spouse and any children who work in your business. Salaries and bonuses accrued in your 2020 fiscal year must be paid within 179 days of your business year end in order to be deductible in the current fiscal year. So, for a fiscal year end between July 6, 2020 and December 31, 2020, a bonus given for the 2020 fiscal year can be paid in 2021—meaning your business will get the deduction in the 2020 fiscal year, but your family member won’t be taxed on the bonus until the following year.
Maximize the Small Business Deduction by minimizing passive investment income
The Small Business Deduction (SBD) is one of the most common tax advantages available to Canadian-controlled private corporations (CCPC). It reduces both the federal and provincial corporate tax rates on the first $500,000 ($600,000 in Saskatchewan) of active business income for qualifying businesses. Depending on your province or territory, the SBD can reduce your overall corporate tax rate by 12.5-19.0% for 2020. This allows for a significant tax deferral when active business income is retained in a company, resulting in significantly more after-tax income available for investment. Retaining income in the corporation will also help with cash flow.
The passive investment income rules that came into effect in 2019 can decrease the amount of active business income eligible for the federal SBD. Under the new rules, the SBD is reduced by $5 for each $1 of passive income over $50,000 in the previous year. Once the previous year’s passive income reaches $150,000, the SBD is eliminated. Passive income is also referred to as ‘adjusted aggregate investment income’ (AAII) and basically includes investment income and taxable capital gains in excess of the current-year allowable capital losses from the disposition of passive investments.
If your corporation is approaching the passive income threshold of $50,000, here are some broad suggestions to preserve access to the small business deduction:
- Adjust your investment mix to hold more equity investments within your corporation rather than fixed income investments
- Invest in an exempt life insurance policy
- Set up an Individual Pension Plan (IPP)
Since passive income is net of expenses, you may also want to consider the related expenses incurred to earn investment income. For example, interest expense, investment counsel fees, and salary paid to you as owner-manager to earn investment income could all reduce passive income, as long as the amounts are reasonable.
Accelerate the purchase of depreciable assets
Claim capital cost allowance (CCA) on depreciable assets acquired and in use before your fiscal year end to help reduce your business’s income in this fiscal year.
The recent Accelerated Investment Incentive Property (AIIP) rules allow an increased first-year capital cost allowance (CCA) deduction for eligible depreciable property acquired after November 20, 2018 and available for use before 2028 (with a gradual phase out beginning after 2023). The rules provide an enhanced first-year CCA of up to 1.5 times the annual net addition to the class and suspend the existing half year rule, which can result in an enhanced first-year CCA claim three times greater than what it would have been prior to the introduction of the AIIP rules.
All capital property subject to CCA rules is generally eligible for the accelerated deduction, except for manufacturing and processing (M&P) and specified clean energy vehicles and equipment. These are eligible for a 100% CCA deduction, allowing them to be fully written off in the first year they become available for use, specifically:
- eligible M&P and specified clean energy equipment acquired after November 20, 2018 and available for use before 2024 (subject to a gradual phase-out if the equipment is available for use after 2023 and before 2028)
- eligible zero-emission vehicles purchased on or after March 18, 2019 and available for use before 2024 (subject to a gradual phase-out if the vehicles are available for use after 2023 and before 2028)
Delay the sale of assets with accrued gains until after year end
Consider delaying the sale of capital property with accrued gains until the start of your next fiscal year. This will allow you to claim one additional year of CCA while also postponing any recaptured CCA or capital gains by a year.
Some additional tax considerations
- Make charitable donations and provincial political contributions (subject to certain limits) before year end.
- Repay any shareholder loans from your corporation no later than the end of the tax year following the year in which the amount was borrowed, otherwise the loan amount may be subject to personal income tax.
- Ensure that all applicable tax has been correctly charged, collected, and remitted on taxable supplies, and that all input tax credits and refunds have been claimed on eligible expenses.
- Pay your final corporate income tax balance, and all other corporate taxes payable under the Income Tax Act, within two months after year end to avoid non-deductible interest charges and penalties.
- Consider any COVID-19 payment extensions available to your business.
- If your business participated in COVID-19 government relief programs, remember that any assistance received under the CEWS and CERS is taxable in the year it was received. The forgivable portion of your CEBA loan will also need to be included as taxable income for the year received.
S+C Partners is committed to helping you
Tax strategy can play an important role in achieving your financial objectives. Our team is here to support you. We are proactive in identifying potential issues and resourceful in designing strategies that minimize tax liabilities and build flexibility into your planning. Please call us at 905-821-9215 or email us at firstname.lastname@example.org if you have any questions or require any assistance.