Proposed Morneau/Trudeau Tax Changes – What You Need to Know
October 2, 2017 – Small Business Needs
Let’s face it, taxes are not something the public likes, nor understands. When it comes to taxes, most of you want to know to two things, where do I sign, and how much do I pay? Of course there’s a smile on your face when you get money back ☺.
Here’s what you need to know about the proposed July 18th Morneau/Trudeau tax changes, as there has been a lot of fear-mongering by self-interest parties:
- If you have a small family business and you are paying your children and spouse something they are truly not earning, all Morneau is doing is putting into place a “reasonableness test” that CRA auditors have been trying to enforce in an ad hoc fashion anyway. For adult children over 17 and under 24 years old, anything paid in excess of what would be a reasonable amount would be taxed at the highest personal tax rate instead of at their lower rate. What is considered “reasonable”? you ask. For starters, the new proposed law says that adult children in this age group must be employed on a regular, continuous and substantial basis. If they are 24 and older, they only need to be engaged in the business, but the business owner will have to show that their pay, whether by wages, or by dividends as shareholders of the corporation, is justified by their contributions to the business. The same holds true for a spouse who receives wages or dividends from the business. What kind of contributions to the business, you ask? The reasonableness test will not only include labour contributed, but when it comes to dividends, CRA will be looking at things like assets contributed, or risks assumed by the adult children or spouse. For example, perhaps the spouse guaranteed a business loan which would justify as a contribution to the business that way. That’s where I come in to prepare your business accordingly to comply with these rules.
- What’s all the commotion from the doctors? In 2005, the Ontario government cut a deal with the doctors, in lieu of higher fee increases, doctors received a benefit relating to their incorporated practices. They were given, unfairly I might add, an advantage that other professionals like myself couldn’t do. They were allowed to have their spouses hold non-voting shares of their professional corporations. What does that mean? The doctor could “income split” with the spouse by way of dividends, which were taxed at the spouse’s lower rates. What do the new proposed rules mean to a doctor’s practice? The same they mean for all small businesses, show me the contribution made by the spouse to justify the dividend. It’s only fair.
- The draft legislation for the new proposed “income splitting” rules above become effective January 1, 2018.
- Another law with draft legislation effective January 1, 2018 is about removing the ability for minor children under 18 to use the capital gains exemption. The capital gains exemption is used by shareholders of small businesses to shelter $835,716 of growth or capital gain in the business when the shares are sold. In the past, tax planning included having a family trust own the shares of the small business, and beneficiaries of the trust would include minor children. When the shares of the business were sold, each child could use their own capital gains exemption of $835,716, effectively multiplying the use of the exemption to shelter a very large growth or capital gain in the business.
- The last item of what you need to know has no draft legislation at the moment but has caused quite a stir among small businesses owners. Small business corporations pay a very attractive 15% corporate tax on the first $500,000 of what we call “active” business income. So if the business has $100 in active business income, it pays $15 to the taxman, and the business has $85 left to invest in the corporation. When you compare what individuals pay on $100 of salary at the top rate of 53%, or $53, it appears unfair. Why the favourable rate for small business corporations? you ask. Because the government intended this to be an incentive for small businesses to reinvest the $85 back into business, such as expanding and hiring more employees, or buying equipment. But some businesses were investing this up front money in “passive” income earning investments such as stocks or bonds and getting dividends and interest instead. And if the business was making more than $150,000 in dividends from stocks, it had a lower tax on this dividend income than what individuals would pay on that amount of dividend income. In addition, Morneau is calling the passive investment “dead money” as it is not being reinvested back into active business assets of the business as the law intended to be done. So to discourage investing the $85 in passive income earning investments Morneau is proposing a higher effective tax on this passive income. Morneau says this would boost economic growth by half a percentage point of GDP. This makes economic sense.
Notice to Reader
Dean Constand CPA publishes this blog for information purposes only. Feel free to distribute to colleagues and friends. Although the material has been carefully prepared, it is not a substitute for professional advice.