Now that some election pledges made by the Liberals have been enacted, how could this affect tax and estate planning for your clients?
Marginal tax rates
Described as a “middle-class tax cut,” the federal income tax rate has been lowered from 22% to 20.5% on income between $45,282 and $90,563. The tax cut will be financed by increasing the federal tax rate from 29% to 33% on income higher than $200,000.
If a client has income between $45,282 and $200,000, her tax savings will be up to $680. Those earning between $200,000 and $217,000 will also see minor tax savings, since the higher taxes they’ll pay on income in that range will be offset by the middle-class cut. At incomes above $217,000, the benefits of the middle-class tax cut (worth $680) are wiped out.
In Ontario, salary and other income exceeding $200,000 will now attract a combined rate of 51.97%. And, the top marginal rate will be 53.53% on salary and other income higher than $220,000 (see “Top tax rates”).
Your clients may find it particularly painful if CRA gets more than half of each dollar they earn (it’s worst in New Brunswick, now home to the country’s highest marginal tax rate: 58.75%).
The middle class is affected
Even so-called “middle-class” income earners could now be subject to a tax rate exceeding 50%. This could happen if they sell an asset with an accrued gain, such as a cottage, without claiming the principal residence exemption. An earner’s tax rate could also exceed 50% if, upon death, she has sufficient assets subject to tax, such as RRSP savings. For example, if a client dies having RRSP savings worth more than $200,000 (or potentially less, depending on her other income), some of her income could be subject to a tax rate of more than 50%.
Also, it’s possible that the tax savings described above (up to $680 annually) could be wiped out by a higher tax bill upon death or by a sale of certain assets during a client’s lifetime.
The increase in marginal tax rates should make corporations more attractive as vehicles for tax deferral and income splitting. Consider that the Ontario small business tax rate will be 15% in 2016. Earning business income in a corporation would result in a maximum tax deferral of 38.53% (in Ontario) when compared to earning the income personally. This would mean immediate tax savings of up to $192,650 on income up to $500,000.
- Freeze the estate
By implementing an estate freeze and introducing a discretionary family trust as a shareholder of a corporation, the benefits of income splitting with family members could be magnified. The value of the corporation would be fixed to the shareholder (along with the related tax bill), while the future growth accrues to other family members. Dividends could then be paid to the family trust and distributed by the trust to family members in a lower tax bracket. A client could significantly reduce her tax bill upon death by gradually redeeming her interest in the frozen shares.
- Income split
Other income-splitting strategies, such as using spousal loans at the prescribed rate (currently 1%), would become more attractive, especially for those earning more than $200,000 a year.
- Contribute to RRSPs
The benefit of RRSP contributions will be greater for higher-income earners. Spousal RRSP contributions, in particular, could give a deduction to a high-income earner but be taxable to a lower-income spouse when the funds are withdrawn. With proper planning (and cash flow management), seniors may get a tax break if they can withdraw RRSP funds and keep their income in the lower brackets. However, a higher tax bill may result on death if there are significant RRSP savings, as described above.
Child tax benefits
The Liberals have promised to scrap the Universal Child Care Benefit (which was taxable) and Canada Child Tax Benefit (CCTB, which was non-taxable). A new non-taxable Canada Child Benefit (CCB) has been promised based on family income and the number and age of children in the family. Families with annual income below $150,000 should receive higher benefit payments than before, while families earning more than $200,000 won’t be eligible for the CCB.
Since child benefits will be tied to income, there’s more incentive for taxpayers who have minor children to legally reduce or defer their income in order to maximize tax-free benefits. For example, maxing out an RRSP can reduce a client’s tax bill and potentially increase her tax-free child benefits.
The increase in the annual contribution limit from $5,500 to $10,000 has been eliminated.
The maximum TFSA amount is $46,500 for 2016. Although the annual amount that can be contributed to a TFSA has been reduced, TFSAs can still be useful for tax and estate planning. As long as the TFSA-holder names a beneficiary, upon death the value of a TFSA is not included in the estate of the deceased, thereby reducing probate fees.
Also, the value of the TFSA at death is not included in income on the deceased’s final personal tax return. And TFSAs will continue to be useful in managing income if a person may be subject to the OAS clawback.
Combined Top Marginal Personal Tax Rates, 2016
Prince Edward Island
by Stephanie Dietz, CPA, CA, CFP. She specializes in tax and estate planning at Stephanie Dietz Professional Corporation. firstname.lastname@example.org