Minimizing Your Taxes
October 1, 2009
By Jeff McRae & James Ward Rosenswig McRae Thorpe LLP
In today's economy it's tough for business owners to make money, so keeping the taxman's share of your income to a minimum is key to financial success. Fundamental to minimizing tax is having the righ...
In today’s economy it’s tough for business owners to make money, so keeping the taxman’s share of your income to a minimum is key to financial success. Fundamental to minimizing tax is having the right legal and ownership structure.
There are three important questions in choosing among alternative structures.
Have the benefits of the small business tax rate for the first $500,000 of income been maximized? Canadian tax rules provide for a 16.5% tax rate on the first $500,000 of corporate income for Canadian Controlled Private Corporations. This low level of corporate tax allows for tax savings if properly applied.
(a) In many cases the corporation will use salary and bonus to the employee/shareholder to bring corporate income to a low level. The better strategy is to leave as much income in the corporation as possible after first paying the owners enough to maximize their RRSP contributions — approximately $120,000. The remaining profit should remain in the corporation to be taxed. Corporate tax will be paid and the remaining after-tax profit will be paid to the shareholders as a dividend. The use of this simple strategy will create tax savings of approximately 5% in most cases.
(b) If you are in the enviable position of not needing all the salary and dividends available to support your lifestyle, there is an opportunity for tax deferral. Whether you are the only shareholder or have other shareholders, you should consider using a holding company. When the corporation pays a dividend, instead of it being paid to you it would be paid to your holding company — the new shareholder of the corporation. Unlike when you receive the dividend personally and pay tax on it, when your holding company receives this dividend no tax is paid.
(c) If you currently operate as a partnership, you have the ability to use the Professional Corporation (PC) structure. The usefulness of this structure will depend on your business model. The PC structure allows for each partner to use their own PC to charge the partnership for the services they provide. Each of the PCs could have its own $500,000 small business rate. This structure b ecomes more and more attractive the more partners there are. Have opportunities for income splitting with family members been carefully considered?
The top marginal tax rate in Canada for individuals is 46.4%, paid on every dollar above $115,000 in personal income. By splitting income from an active business with a lower-income spouse and other non-minor family members, significant tax savings can be achieved.
(a) Restructuring your corporation to allow your spouse and adult children to have ownership in the corporation or in the holding company, either personally or through a family trust, will allow you to split income and save taxes. The dividends previously paid to you at the high tax rate of 31% can be paid to them instead, either at nil tax or a very low tax rate. For example, an individual with two children in university could save almost $25,000 in tax if the corporation paid $80,000 in dividends to the children.
(b) Income can be split with minor children, but due to the “kiddie tax” imposed by Canada Revenue Agency, benefits are less lucrative than in the case of adult children. If you personally pay tax at the top dividend rate of 31%, this has to be compared to the 27% rate paid by minor children. The difference gives a saving of 4%, so that on dividends of $40,000 the tax savings would be approximately $1,600.
(c) There are no income splitting possibilities if you use the PC structure on its own. There is, however, a structure that uses a management corporation/partnership. The management corporation would be owned by your spouse and children and would charge a management fee to the PC.
Does the structure maximize the benefit of the government’s generous Scientific Research Tax Credit program?
Between the federal and Ontario programs it is possible to recover over 60% of salary costs incurred for qualified research. However, the program is much less generous for partnerships and proprietorships than for corporations. If you are taking advantage (or planning to take advantage) of the SR&ED program, a switch from a partnership to a corporation structure could be greatly beneficial.
Jeff McRae CA, CFP & James Ward practise with Rosenswig McRae Thorpe LLP, a Toronto-based accounting firm specializing in the professional services sector.
“When your holding company receives this dividend, no tax is paid.”