Tax planning for business owners always requires particular vigilance.
Every year, advisors must take into account legislation and economic factors before choosing strategies, says Tony Salgado, director of Financial Planning and Advice at CIBC.
This is particularly true in 2018 thanks to the changes to income sprinkling rules.
In brief, a tax on split income now applies to dividends paid to family members, except when they are:
- the business owner’s spouse, provided the owner meaningfully contributed to the business and is aged 65 or older;
- aged 18 and older and make “regular, continuous and substantial” labour contributions to the business during the last five years;
- are aged 25 and older and own at least 10% of a corporation that earns less than 90% of its income from services, and isn’t a professional corporation.
There is also an exception for family members who receive capital gains from qualified small business corporation shares and qualified farm or fishing property, if they wouldn’t be subject to the highest marginal tax rate on the gains under existing rules.
These new rules, and the forthcoming passive corporate assets rules, have changed the planning picture for business owners this year.
Salgado suggests asking these questions to develop an appropriate strategy.
Is it a Canadian-controlled private corporation?
The small business reforms only apply to Canadian-controlled private corporations (CCPCs), Salgado points out. If your clients are incorporated, they are likely CPCC owners, but it’s worth checking.
The Income Tax Act defines a CCPC by saying what it’s not. For instance, it’s not:
- controlled by non-residents,
- controlled by public or publicly traded corporations, or
- listed on a designated stock exchange.
How old are your family members?
“Review the ages of all your family members that are in business with you,” Salgado says, “because you may be not subject to [the new] rules if you do have the right ages in your family mix.”
What are those right ages? Thanks to the exemptions, business owners 65 and older “don’t have to worry as much about the income sprinkling rules,” he says.
Further, business owners with adult children aged 25 and older have the option to income-split provided they meet the labour requirements mentioned above.
How many share classes do you have?
Salgado says having multiple classes “allows for a tremendous amount of flexibility in planning,” both for short-term dividend distribution as well as succession and estate planning.
In the new regime, it may also be useful to have different classes for different family members.
“Starting January 1, 2018, there is very limited ability to income-split with family members between the ages of 18 and 24,” he says. “We want […] clients [and] prospects to understand that if you do have anyone within that age range, we need to review your distribution planning going forward.”
For instance, clients should treat children inside the range differently from those outside the range so as not to run afoul of the income sprinkling rules. And that means issuing them shares from different classes; it may even mean creating a share class for each family member.
Otherwise, “if your 19-year-old son and 30-year-old daughter have the same class of shares, we [are] restricted in terms of how we can provide dividends to the two of them separately,” he says.
Having a class for each family member also provides flexibility going forward. “If you don’t provide a dividend to your 23- or 24-year-old this year, it doesn’t mean you can’t give them a dividend next year,” he says.
What kind of income is the corporation earning?
The Department of Finance has indicated that the 2018 federal budget will include draft legislation concerning passive assets in a CPCC.
“We expect that the integration or the overall tax liability for investing inside of a corporation may become very punitive, or very highly taxed,” Salgado says. Once the rules are out, advisors will need to understand the character of income that clients are earning, “inside [the] corporation versus outside.”
How many hours per week are family members working?
Salgado says family members need to work at least 20 hours a week on average in the business to be considered as “regular, continuous and substantial” employees.
Here, as with all the provisions of the new rules, mistakes will be costly, he warns. “If the tax on split income rules apply to your dividends, the tax liability will be at the highest marginal rate.”
This article is part of the AdvisorToGo program, powered by CIBC. It was written without input from the sponsor.