Morneau’s federal budget announced earlier this year informed us how the government will treat passive income in a Canadian Controlled Private Corporation. (CCPC) The government’s main concern was that under the current rules a “tax deferral advantage” exists since tax on active business income is usually lower than the top personal marginal tax rate. Therefore if the corporate funds were invested for a long period of time, shareholders might end up with more after-tax amount than if it was invested personally.
Limiting Access to the Small Business Tax Rate
A key objective of the budget is to decrease the small business limit for CCPCs with a set threshold of income generated from passive investments. This will apply to CCPCs with between $50,000 and $150,000 of investment income. It reduces the small business deduction by $5 for each $1 of investment income which falls over the threshold of $50,000 (also known as the adjusted aggregate investment income). This new regulation will go hand in hand with the current business limit reduction for taxable capital.
The time to act is now, since these changes will be effective January 1, 2019, a discussion and plan should be prioritized now, since 2018 will be the “prior year” of 2019. To avoid the reduction of income eligible for the small business tax rate, business owners need to minimize or keep the amount below $50,000 of the “adjusted aggregate investment income” (AAII) in 2018.
We’ve listed some solutions on how to do this:
1) Corporate Owned Insurance: Exempt life insurance does not produce passive investment income unless there is a disposition. Put a portion of the corporation’s passive investments into a life insurance policy and reduce passive investment income and limit the erosion of the small business limit. Insurance concepts:
● Insured retirement program: Provide additional retirement funding through transferring excess corporate funds into whole life or universal life insurance. The funds inside the policy grow “tax free” to create significant cash value. At some point when there is a need for cash, the policy is pledged as collateral for a bank loan. The bank loan doesn’t need to be repaid until the life insured dies and the death benefit is used to repay the loan. Any remaining death benefit is paid out.
● Estate bond: Transfer corporate wealth to the future generation by utilizing whole life or universal life insurance. Essentially replace taxable investment with life insurance, increase funds for a future generation upon death, reduce tax and create a strategy to move funds out of the corporation tax free (through the Capital Dividend Account.)
● Corporate held Critical Illness with Return of Premium: Purchase corporate owned critical illness, since it doesn’t produce any investment income.
2) Pay enough salary/dividends to maximize RRSP and TFSA Contributions: A salary of $145,722 will allow the max 2018 RRSP contribution is $26,230 (18% of $145,722). Make sure you also pay enough salary/dividend to maximize your annual $5,500 TFSA contribution.
3) Individual Pension Plan (IPP): The corporation contributes to the IPP and income earned in the IPP doesn’t belong to the corporation. This should only be considered when the AAII is over $50,000.
4) Deferred Capital Gains: Capital gains are 50% taxable and are only 50% included in the AAII.
Talk to us, we can help you figure out the best solution for your unique situation.
How to Make the Best of Inheritance Planning
Inheriting an unexpected, or even an anticipated, lump sum can fill you with mixed emotions – if your emotional attachment to the individual who has passed away was strong then you are likely to be grieving and the thought of how to handle your new-found wealth can be overwhelming and confusing but also exciting. One of the best pieces of advice in this situation is to give yourself some time before making any binding financial decisions. The temptation to quickly put the money to so-called ‘good use’ or to rush out and spend it can be strong but you must allow the news to sink in and also take some time to consider your options before you embark on the process of dealing with the inheritance. In the short term, put the money away in a high interest savings account and take time to research and think carefully about your financial goals and objectives and how this inheritance can help you to secure and maximise your financial future in the best way.
Although there is no one-size-fits-all approach to dealing with larger sums of money, here are some useful ideas of where to start.
Reduce your debt burden
If you have significant or high-interest debts, one of the safest options of all is paying this debt down. Not only will you achieve a guaranteed after-tax rate of return of your current interest rate, it can also add to your feeling of financial security and potentially offer you a more consistent financial picture. Debt often carries with it a significant interest rate – particularly on credit cards and overdrafts for example – so in many cases, eliminating this burden should be considered as one of your main priorities.
However, you may like to take careful note of the option below regarding investing the money instead as much depends on the prevailing interest rates and, of course, your appetite for risk, as you may well find an investment option with a potentially higher return more attractive.
A particularly effective way of investing an inheritance is to add it to your retirement savings – especially if your nest egg is not looking quite as healthy as it should due to missed savings years for example. Those with lower or less reliable incomes should look upon this option as a great choice in particular.
After considering your own future financial needs, giving some of your wealth away to either charities or to family and friends is a good option to share out some of your inheritance to those who could benefit from it. What’s more, donating to charity can also offer you some tax breaks which may reduce your overall tax burden.
Many individuals see this philanthropic route as offering them the opportunity to do something meaningful and rewarding with their wealth and contributing towards their own sense of moral duty and emotional wellbeing.
Make a spending plan
Of course, you are likely to be keen to spend some of your wealth on yourself and your family, particularly if your financial situation means that you have previously had to be more careful and prudent with money than you would have liked. A great way to do this is to create a spending plan so that you can enjoy the benefits of spending, without it significantly eating into money set aside for your financial planning goals. You could, perhaps, aim to set aside 10% of the inheritance just for yourself and loved ones to enjoy. The proportion will naturally depend on your circumstances but, in principle, it’s a great idea as it allows you to balance sensible saving and investments with some short-term enjoyment of your wealth.
Talk to us, we can help.
Working with a professional to help you to make sense of your finances can be a wise move, but for this relationship to work effectively it is important that you understand what to expect from your financial advisor.
What can your financial advisor help you with?
What should your financial advisor inform you of?
What will your financial advisor need from you or need to ask you about?
If you’re looking to achieve your financial goals, talk to us. We can help.