As a shareholder of a private corporation or beneficiary of a testamentary trust, you enjoy many tax advantages. However, what you may not know is that a perfect storm is headed your way.
Measures in the 2015 Federal Budget (released by the Conservatives) will begin to take effect in 2016. Colliding with those measures are key tax initiatives from the Liberal party. All signs point to rising personal tax rates in 2016 and future years.
So what can you do in 2015 to help ease the tax burden?
Owners of private corporations:
Over the next four years, the Harper government proposed a 2% tax reduction on the first $500,000 of business income earned by a Canadian controlled private corporation. As a result, ironically, tax rates on non-eligible dividends (NEDs) will increase by approximately 1.25% for individuals in the top tax bracket in Manitoba.
The Liberals will keep this measure in place and have also proposed to increase the top personal federal rate by 4%. They will also explore ways to restrict the ability for families to avoid higher tax rates by paying dividends to lower income family members.
As a result, many corporation owners are considering taking more income in 2015 to avoid higher tax rates in 2016 and future years.
The key will be to determine to what extent a lower 2015 tax rate makes up for lost tax deferrals and higher tax rates in the future. If family members are shareholders of your corporation directly or indirectly through a family trust, you should also consider paying them dividends and taking advantage of their lower tax brackets while you still can.
Corporately held investments:
The cost of earning taxable investment income through a corporation will also increase as a result of these changes. It’s generally advisable to draw funds tax efficiently from a corporation when possible. Having a corporation repay shareholder loans, paying any available tax free capital dividends, paying eligible dividends to recover refundable tax and even donation planning are all tax efficient strategies of extracting funds from a corporation.
Annual year-end tax planning should consider triggering capital gains in a corporate investment portfolio to use up non-capital loss carryforwards and create additions to a capital dividend account.
Alternatively, you might consider triggering capital losses to offset capital gains incurred in the current year or in the past three years. It is common to pay out a capital dividend prior to triggering a capital loss as capital losses reduce your capital dividend account balance.
Trustees and beneficiaries of testamentary trusts:
Historically, it’s been common practice to describe testamentary trusts in one’s Will to be created and hold investments for beneficiaries after death. Investment income would be taxed at the trust’s lower tax rates and the trust could also distribute capital, when needed, tax free to beneficiaries.
A big change for 2016, even for existing testamentary trusts, is that income earned and retained by such trusts in 2016 and future years will be subject to the top personal tax rate. The main exception is a trust set up for a disabled beneficiary.
There continues to be many non-tax reasons for setting up testamentary trusts. However, the loss of graduated tax rates and a higher top personal tax rate will largely eliminate the tax benefits, except where there are alternate income beneficiaries in a low tax bracket.
Trustees of testamentary trusts might consider triggering capital gains in 2015 to take advantage of the lower tax rates. We expect that many testamentary trusts currently in place, purely for tax reasons, will be wound-up in 2016 to simplify and to avoid administrative costs.
I am personally caught in this situation, so I am triggering extra income in 2015, but maintaining the trust into the future, as I may be able to save tax by allocating income to my future grandchildren.
Speak to your tax and legal advisor before acting, as the best course of action will depend on your situation and plans for the future. I’m grateful to mine, including Cedric Paquin here at our firm, for wise counsel and good ideas for this article.
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Dollars and Sense is meant as an introduction to this topic and should not in any way be construed as a replacement for personalized professional advice.
Please consult legal, tax, insurance and investment experts for advice on your unique situation.
David Christianson, BA, CFP, R.F.P., TEP, CIM is a financial planner and advisor with Christianson Wealth Advisors, a Vice President with National Bank Financial Wealth Management, and author of the book Managing the Bull, A No-Nonsense Guide to Personal Finance.