1. Salary and Dividend Mix
As a business owner, one essential part of tax planning is determining the right mix of salary and dividends for both yourself and your family members.
The following are key considerations when determining how to distribute money from your corporation:
- Pay a salary to family members who work for your business and are in a lower tax bracket. This enables them to declare income, contribute to the Canada Pension Plan (CPP) and create contribution room towards their Registered Retirement Savings Plan (RRSP). You must be able to prove the family members have provided services in line with the compensation allotted.
- Pay dividends to family members who are shareholders in your company. Depending on the province or territory of residence, the amount of dividends one can receive without incurring income tax will vary.
- Distribute money from your corporation via income sprinkling. Income sprinkling shifts income from a high tax-rate individual to an individual with a low or nil personal tax rate. However, this strategy can cause issues due to Tax on Split Income (TOSI) rules. A tax professional can help you determine the best way to “income sprinkle” so none of your family members are subject to TOSI.
- Keep money in the corporation if neither you nor your family members need cash. If your company qualifies as a Canadian-Controlled Private Corporation claiming the small business deduction, your corporation can defer the taxes by retaining the income.
No matter which strategy you choose to distribute money from your corporation, keep the following in mind:
- Your marginal tax rate as the owner-manager
- The corporation’s tax rate
- Your RRSP contribution room
- Your current health condition
- The impact of payroll taxes
- The effects of the chosen strategy on CPP contributions
- Other eligible deductions and credits (e.g., charitable donations, childcare, or medical expenses)
An essential part of year-end tax planning is determining appropriate compensation methods. The following are the main things to consider:
- Can you benefit from a shareholder loan? A shareholder loan is an agreement to borrow funds from your corporation for a specific purpose. The interest from the loan might be deductible if the proceeds of the shareholder loan are used to produce income from business or property.
- Do you need to repay a shareholder loan to avoid paying personal income tax on your borrowed amount?
- Is setting up an employee profit-sharing plan a better way to disburse business profits than simply paying out a bonus?
- Keep in mind that when an employee cashes out stock options, only one party (the employee OR the employer) can claim the tax deduction.
- Think about setting up a Retirement Compensation Arrangement (RCA) to help fund you or your employees’ retirement.
3. Passive Investments
One of the most common tax advantages available to Canadian-Controlled Private Corporations (CCPC) is the Small Business Deduction (SBD). For qualifying businesses, the SBD reduces your corporate tax rate.
However, if your corporation earns passive investment income, the SBD decreases by five dollars for every dollar of passive investment income over $50,000 your CCPC earned the previous year. The best way to avoid losing a portion or all of the SBD is to ensure that the passive investment income within your associated corporation group does not exceed $50,000.
To preserve your access to the SBD, consider the following:
- Defer the sale of portfolio investments as necessary.
- Adjust your investment mix to be more tax efficient. For example, you could choose to hold more equity investments than fixed-income investments. Only 50% of the gains realized on shares sold is taxable, but investment income earned on bonds is fully taxable.
- Invest excess funds in an exempt life insurance policy. Any investment income earned on this policy is not included in your passive investment income total.
- Set up an Individual Pension Plan (IPP). An IPP is like a defined benefit pension plan and is not subject to the passive investment income rules.
4. Depreciable Assets
Another strategy to consider for year-end tax planning is accelerating your purchase of any depreciable assets. A depreciable asset is a type of capital property eligible for the Capital Cost Allowance (CCA) tax deduction.
Here are two ways to make the most of tax planning with depreciable assets:
- Make use of the Accelerated Investment Incentive. Some depreciable assets are eligible for an enhanced first-year allowance with this incentive.
- Purchase equipment such as zero-emissions vehicles and clean energy equipment eligible for a 100% tax write-off.
Another essential part of tax planning is to make all your donations before the end of the year—both charitable donations and political contributions.
For charitable donations, you need to consider the best way to make your donations and the different tax advantages of each type. For example, you can:
- Donate securities
- Give a direct cash gift to a registered charity
- Use a donor-advised fund account at a public foundation—a donor-advised fund is like a charitable investment account
- Set up a private foundation to solely represent your interests
Reach out to your Financial Planner and Accountant to confirm the tax implications of each type of charitable donation.
6. Make the Most of COVID-19 Relief Programs
While some COVID-19 relief programs have ended such as Canada Emergency Wage Subsidy (CEWS) and Canada Emergency Rent Subsidy (CERS), others are still available.
Determine if your business can benefit from any of the following relief programs:
- Canada Recovery Hiring Program (CRHP). This program will continue to run until May 2022. If your business continues to experience a decline in revenue compared to pre-pandemic levels, CRHP will provide support to assist in hiring new staff or increase the wages of your existing staff.
- Tourism and Hospitality Recovery Program (THRP). This new program provides wage and rent support to businesses in the tourism and hospitality industry such as hotels and restaurants. Eligible businesses must have an average monthly revenue reduction of at least 40% over the first 13 qualifying periods for the CEWS, and a current-month revenue loss of at least 40%.
- Hardest Hit Business Recovery Program (HBRP). The HBRP provides rent and wage support of up to 50% for eligible businesses. They must meet two conditions: an average monthly revenue reduction of at least 50% over the first 13 qualifying periods for the CEWS, and a current-month revenue loss of at least 50%.
- Lockdown Support. If there is a public health lockdown causing sufficient revenue loss, your business would be eligible for support at the same subsidy rates as the THRP.
Pay attention to which benefits are considered taxable income. If you received assistance from government assistance programs including the CEWS, CERS, and CRHP; this assistance is taxable as income.
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