Although an executive employee has fewer opportunities to minimize tax than a business owner, there are still a number of things an executive client may want to consider.
An employee should confirm what company pension plan options they have, as membership in the company pension plan may be beneficial—particularly if it’s a defined benefit plan—even though it creates a pension adjustment that may reduce or eliminate any RRSP deduction room.
In addition, some employers may even offer certain executives the opportunity to enhance their retirement income benefits through an individual pension plan (IPP) or a supplemental executive retirement plan (SERP).
Flow-through investments can reduce tax on employment income, but the executive should be aware of the risks. The strategy typically involves making an investment in a limited partnership that invests in shares of junior resource companies (oil, gas, mining, etc). The government allows these resource companies to flow through their expenses to individual investors, who can then deduct these expenses on their personal tax return against any income.
For example, a flow-through investment of $10,000 can eliminate current tax on $10,000 of T4 income. But keep in mind, there’s generally an 18- to 24-month holding period required by the flow-through company. So, assuming no movement in the price of the flow-through investment after two years, the benefit of this strategy can be illustrated as follows using top Ontario tax rates: The after-tax profit after two years equates to an annual after-tax return of about 11%. Due to the tax savings at purchase, the value of the investment can decrease by 30% after two years, and the investor will break even. Some flow-through investments also provide a mineral tax credit, while others may trade immediately on the secondary market at a discount.
That said, it’s important to consider the quality of the investment—not just the potential write-off.
Many executives are keen to contribute to causes they care about, while also reducing their tax. To encourage individuals to increase their charitable giving, there’s a tax incentive for those who wish to donate publicly traded securities (traded on a prescribed stock exchange).
Executives with appreciated public company stock or stock options should consider donating the stock in kind (or within 30 days after an option exercise) instead of donating cash, so the gain is eliminated and a donation tax receipt is received equal to the market value.
The flow-through share strategy and charitable giving can be combined to eliminate the capital gains tax on the flow-through investment—significantly reducing a client’s out-of-pocket donation cost to pennies on the dollar.
Some executives may have stock-based compensation programs such as employee stock options, deferred shares and/or deferred share units. While the gain on an employee stock option is taxed as employment income, in most cases a 50% deduction is available, so ultimately, only half the gain is taxable similar to capital gains tax treatment.
Deferred shares and deferred share units (DSU) allow an executive to defer tax on a portion of their compensation for either three years (deferred shares) or until retirement or termination (DSUs). The payout is all taxed as employment income, but the executive will enjoy many years of tax deferral first.
Personal services business
A more exotic strategy to reduce and defer tax on employment income is for the employer to pay the executive’s income to a corporation instead of directly as T4 income. In this case, the corporation would likely be deemed a personal services business (PSB), meaning the lower small business tax rate of 16% (although this varies by province) would not be permitted, but the general corporate tax rate of 31% (also varies by province) is allowed. This rate is much lower than the top personal tax rates on employment income of 46% (again, varies by province).
In addition, dividends could be paid from the corporation to a low-income spouse or adult child shareholder for further tax savings. The challenges with the PSB are employer acceptance, the requirement to charge sales tax, the loss of employee benefits and the limitation on deductions allowed.