My name is Mark Goodfield. Welcome to The Blunt Bean Counter ™, a blog that shares my thoughts on income taxes, finance and the psychology of money. I am a Chartered Professional Accountant and a partner with a National Accounting Firm in Toronto. This blog is meant for everyone, but in particular for high net worth individuals and owners of private corporations. The views and opinions expressed in this blog are written solely in my personal capacity and cannot be attributed to the accounting firm with which I am affiliated. My posts are blunt, opinionated and even have a twist of humor/sarcasm. You've been warned. Please note the blog posts are time sensitive and subject to changes in legislation or law.

Monday, January 11, 2016

The Top 1% are not Happy Campers

A large percentage of my client base is made up of Canada’s “top 1%” of wage earners. They have been vociferous is expressing their unhappiness with the announced marginal tax rate increases for high income earners. They are also very concerned a second shoe will drop, that being the possibility the government will eliminate the small business deduction for many of their corporations.

So who are the “top 1%”? According to a 2013 report by Statistics Canada, Canada's top 1% earned an average income of $454,800. To be considered in the top 1% of income earners in Canada for 2013, a tax-filer would need to have a minimum total income of $222,000.

The 50% Psychological Barrier


On December 7, 2015, Finance Minister Bill Morneau confirmed that for Canadians with incomes over $200,000, their marginal tax rates will increase from 29% to 33%. If you live in Ontario and make more than $220,000, this means you will be paying 53.53% on any dollar earned over the $220,000. I am not a psychologist, but it is very clear to anyone who deals with high-net-worth individuals, that once marginal rates go beyond 50%, they break an invisible psychological barrier that impacts taxpayers thinking, if not their actions. Simply put, you are now paying more money to the government than you keep.

Potential Restriction on Claiming the Small Business Deduction


Currently, small business owners that carry on an active business pay corporate tax at a rate of 15.5% on the first $500,000 of taxable income (subject to various restrictions and sharing of the limit with related corporations). If a corporation is not eligible to claim the small business deduction ("SBD"), they would be subject to a 26.5% tax rate, an 11% increase. [Note: To be clear. This 11% increase is only an increase in the taxes you would pay at the corporate level. So instead of deferring say 38% when you leave money in your corporation (53.5%-15.5%), you would now only be deferring 27%. The absolute income tax increase to you when you when you flow your corporate money to yourself as a dividend or a salary is very small].

As discussed below, the Liberals have floated placing restrictions on the use of the SBD. This has many small business owners anxious that they may have to pay the higher 26.5% tax rate.

In a prior blog post, I noted the following comments made by Prime Minister Justin Trudeau in this article  by the National Post. The Prime Minister stated “that several studies have shown that more than half of small business owners are high-net-worth individuals who incorporate…to avoid paying as high taxes as they otherwise would”. The Post noted that “in that group are doctors and lawyers, groups that may find themselves squeezed by the policy Trudeau loosely outlined this week”.

Mr. Trudeau went on to say that “We want to focus on helping small business owners who are working hard, who are creating jobs for members of their community and serving their community. We are committed to evidence-based policies and I will make no apologies for that.”

Some tax pundits suggest that the Liberals will implement legislation similar to Quebec. In general, Quebec’s legislation says the following corporations would be eligible to claim the small business deduction: 

1. any corporation that employs more than three full-time employees in its business throughout the year or that would usually have used the services of more than three full-time employees had financial, administrative, maintenance, management or other similar services not been provided to the corporation in the year by a corporation associated with it; and

2. any corporation in the primary or manufacturing sector.

My Observations and Experience


I personally cannot ever recall my clients being so vocal over a tax increase and concerned about the possible changes to the small business deduction. I have had several voice their displeasure about these measures. I asked a couple of them if I could discuss their situations in general and they agreed.

One client is a serial entrepreneur in northern Ontario. At a very young age, she built up a hi-tech company and sold a division of the business to a major corporation. At that time she had over 75 employees. She subsequently rebuilt her original company with a new product and incorporated a very successful second company. Following the announcement of the increase in tax to almost 54%, she has started implementing a departure plan, with the intention to set-up offshore and leave Canada within the next ten years. There are several reasons why she wishes to leave Canada, many being philosophical in nature (I would like to list them, as they are very sound and interesting objections, however, we agreed to limit my discussion to her general situation), but the tax increase was the straw that broke the Camel’s back so to speak.

Most people would probably agree, this is not the type of person you wish to chase from Canada.

A second client is a professional nearing retirement age. He basically said to me that why should he continue to work when he does not need the money. He says he is now planning to retire early. He also told me, he had recently attended two Christmas parties and all the room was talking about was the personal tax increase and the possibility many professionals will lose their access to the small business deduction.

The above is an example of tax law changing behaviour in a non-productive way. 

What the Youth of the World have to Say


During a recent dinner, the tax issue was brought up by a guest (not by me, I have enough of this issue at the office). My children who are young adults had this to say:

1. Are individuals who want to leave Canada being selfish? They make a lot of money, so why do they mind paying income tax?

2. If individuals could tell the government what buckets to put their tax dollars towards, would that make it more palatable?

I found both of these comments very insightful, although said through the prism of youth.

Are you selfish if you are willing to leave a country because you do not wish to pay high levels of income tax? Since this discussion would be a book on its own, I will only say the following. I think that every person has and is entitled to, their own marginal income tax “breaking point”. In addition, as noted above, I would trivialize the discussion by saying income tax increase alone may cause some people to leave Canada. While that may be the case for some, I would suggest for most others, while income tax increases maybe a trigger for them considering leaving Canada, it is only one of several considerations.

I loved the tax bucket idea and would suggest many individuals who would consider leaving a country because of taxes would possibly reconsider if they could actually allocate their tax dollars to where they think would be the most useful. However, since this is a fanciful notion and would essentially eliminate the need for government, it is a bit of a non-starter.

The issue of high marginal tax rates is very contentious. This short blog post cannot do the topic any justice. However, it is clear that taxing the wealthy can lead to splits among socioeconomic status, political leanings and philosophical differences on taxation and the common good. What I can tell you is: there is significant unhappiness amongst the top 1%, and probably the top 20%, and if and when legislation comes in restricting the small business deduction, I think it may manifest itself further. Here’s hoping sound business decisions do not become clouded by tax considerations.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.

39 comments:

  1. I don't believe that Canadians mind paying taxes per se. After all, we do derive some benefit from central planning such as medicare, CCP, etc.
    What they do mind is wasteful spending of those worked for tax dollars by bureaucrats who have little to no idea what they are doing in relation to other departments.

    The sdvertisements by the QC government to "refuse" to pay under the table for work done and paid out of your own pocket is a good example when one considers the latest knuckle rapping inquiry in to criminal manipulation of governemnt contracts. A few get kickbacks for fixing contracts that are paid for by the taxpayer. They get their knuckles rapped, we get to keep on paying. So please explain to me why we should refuse to save money on aftertax dollars if the governments can not administer said funds in a logical and trust worthy manner.

    Don blame people for wanting to keep the money they worked for. Our taxes would be less if the funds collected were properly administered. How much money was wasted on the cancelled helicopters, the cancelled power plants in Ontario, maybe the concelled F35 fighters, etc, etc

    RICARDO

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    1. Thx Ricardo

      I think you speak for many people.

      Delete
  2. Obviously, even if the small business deduction is no longer available a professional or business owner can at least set up a personal pension plan using the more generous pension laws to reduce the total taxes owing.

    ReplyDelete
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    1. Hi JP

      Anyone interested in learning about private pension plans should read this blog post http://www.thebluntbeancounter.com/2014/12/personal-pension-plans.html

      Delete
  3. As the previous commenter stated, most Canadians don't mind paying taxes, however, if I was making that much money, I might certainly start looking for ways to lower my income, can't really blame them for doing it either.

    ReplyDelete
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    1. BCM,

      What do you mean, with all the income your blog brings in you mean to tell me you are not in the top 1%? :)

      Delete
  4. Hi Mark

    As someone in the top 1%, I totally understand your clients feelings. I think our tax rate is excessive and I will be hurt if the SBD rule is changed as above.

    Nevertheless, at the end of the day, I like living in Canada, my kids and family are here, so I will suck it up until Justin makes a mess and we get the conservatives back in office.

    ReplyDelete
    Replies
    1. Hi Anon

      I have a lot to say about your comment, so I will say nothing. Thx for your thoughts.

      Delete
  5. Your kids aren't too far off the mark. In fact, in some places (New York, for example), you can fill out a form that specifies how you want your highway toll/tax spent. You can tell the government to spend your couple of bucks... perhaps 100% towards roads, or perhaps 50% firefighters and 50% social support systems.

    ReplyDelete
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    1. Hi Anon

      Did not know that; will have to tell my kids. So maybe we get to select where our taxes go towards based on a limited percentage. That would be better I guess than nothing.

      Delete
  6. The focus of this seems to be an 'eat the rich' mentality.

    If they're increasing taxes to cover increased spending, then the conversation should be centered around what the spending is. We're not seeing that conversation happen.

    Which means the real purpose behind the tax increases is punative. Tax the rich, because they make too much money. That's poor reason to make financial decisions, and if the 'rich' want to take their money elsewhere in response, good on them.

    In years past the 50% level seems to be a real breaking point for these people. Exceed it ans some people will pull a gerard depardieu.

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    1. Hi Glenn

      It has been presented, at least in the media if not by the Liberals that the tax increase is supposed to be used at least in part to cover the tax reduction to the middle class -- so punitive vs re-distribution?

      Delete
    2. I don't know if it's necessarily punitive, it's more trying to use the rich to solve the government's problems whether those are from bad decisions or outside forces. The whole point of taxes is that you can't expect a small group of people to pay a cost that large even if the rate was 100%. It's just not enough. As we're seeing now the "tax twist" doesn't balance out and that's just a couple billion dollars.

      Delete
    3. thx Richard, definitely does not appear to be balancing out the more you read.

      Delete
  7. Thank you for the excellent blog post Mark! This has been on our family's mind. We run a small business but do not have 3 FT employees all year so would be hit by this tax increase. My question is: Wouldn't the total taxes to the business owner (for example, if it were one person running their contract work through a business) be similar? When the owner earns the money, corporate taxes are paid. Then when the owner takes the money out, there is another set of personal taxes. Wouldn't this total amount of taxes be similar? I totally agree that this will change how we run our business, very likely in a way that will be worse for the Canadian economy, not better (i.e. we would take more time to enjoy life and less time working like crazy). There truly is a psychological barrier for taxation.

    ReplyDelete
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    1. HI CSBO

      Yes, the 11% difference is mostly a deferral in tax, but there will likely be small overall absolute tax increase. I am going to clarify that in the blog.

      Delete
  8. Confused. Is the 1% threshold reached at $454,800 or $222,000? Your first paragraph states both figures.
    Also, please consider titling your blog posts on the subject line. It's an impossible task to search saved posts as they're currently being sent. Thanks a lot.

    ReplyDelete
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    1. Hi Marni

      The $454,800 income level puts you in the top 1% earners in Canada, it has nothing to do with income tax. Once you make over $220k in Ontario, you are subject to 53.53% tax.

      I try to have the topic area in title, so it can be searched. But like to have fun with the title, so will probably not change, you only have so much fun as an accountant :)

      Delete
    2. The latest I've seen is that you need an income of at least $220k to be in the 1%. Since they all have incomes at least that high their average income is $454k. Think about it this way, the average is never going to the same as the smallest one.

      Delete
  9. And the latest enlightened spending of those hard earned tax dollars in QC according to the Journal de Montreal
    $750K over five years to pay a comedian spokeperson for the CSST (Workman's safety and security commission). All this while the CSST fights claims in court to make sure they do not pay out too much.

    And (simialr to Ontario's Windmill generators) Hydro Quebec is paying I believe it is TRP $150K per year for a mothballed brand new (2006) generating plant that if it were working would be producuing electricity that Hydro Quebec does not need. It is a thirty year contract. Again, sinilar to Hydro One paying the wind farms to NOT generate un-needed power.

    The many brilliant minds of our enlightend and I am sure university educated bureaucrats.

    And then they wonder why we, the un-educated masses, try to pay less taxes????

    Excuse me if I included some .1%'s in the un-educated masses

    RICARDO

    ReplyDelete
    Replies
    1. Ricardo, please tell me what you really think :)

      Delete
  10. Now that would be a long rant.
    Basicly there is just too much waste in the system. And a lot of it has to do with people not caring about consequences of their decisions but jsut looking at their aspect only. To make a loaf of bread it takes more than one ingredient.

    RICARDO

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  11. So much complaining about a minor tax increase of 3%. If you read this wonderful explanation, historical tax rates for the top 1% average about 65%.

    https://www.policyalternatives.ca/sites/default/files/uploads/publications/National%20Office/2015/10/How_Much_Tax_Could_Canadas_Top_1_Pay.pdf

    " most OECD countries now have significantly higher top marginal tax rates than Canada. Nevertheless, in almost all countries the existing top marginal tax rate is below the revenue maximizing tax rate [of 65%]".

    So you see, they're actually *compromising* by letting you off with only 53%.

    ReplyDelete
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    1. Hi Joel

      Thx for your thoughts and link. As a former guest blogger on this blog who told his story as an entrepreneur who had their own business, I wonder if you would see it the same way if you were taxed at 53% and your SB rate went up 11%? Just saying :)

      Delete
  12. The newly dictated 4% Trudeau Tax is particularly unfair and unjust to entrepreneurs who invest dollar and sweat equity, and accept low incomes during the start up years. The Trudeau Tax, along with the Wynn Tax of 1.9% combine to curtail employment. Understandably, Trudeau was looking for ways to fund the import of tens of thousands of migrants in time for them to obtain Canadian citizenship to vote for the Liberals in the next Federal elections; however, the net result will invariably cost Canadian jobs - and in particular "jobs with a future". The net consequence of the one-two punch of the Trudeau Tax and the Wynn Tax doesn't bode well for Ontario or for Canada.

    The manner in which the Trudeau Tax was introduced and is promoted by the Liberals is divisive and driven by the negative emotion of envy. This is typical of what we should expect until we wise up and return a responsible government.

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    1. Hi Ami

      I guess u r not into being politically correct :)

      Delete
  13. Sometime the truth hurts. Certainly the comment about some using incorporation and the SBD to avoid paying personal income tax is definitely true. MDs will say that the option of incorporating and using the SBD was offered up in lieu of the government providing an appropriate pension plan for MDs... this may or may not be true but it is almost certainly not down in writing anywhere and the one thing that is certain is that subsequent governments will change the rules when it is expedient. The SBD also allows lower total taxes to be paid by income smoothing. The comment on changing behaviour by removing the incoporation option may be true but it is also either naive or disingenuous to think that the presence of the option also doesn't affect behaviour in potentially negative ways.

    Happy to live in Canada, pay taxes and benefit in countless ways.

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    1. Hi Anon,

      Thx for your comments. Nice to see some patriotism. There are clearly two schools of thoughts on this topic based on the comments. I understand both views and everyone is entitled to their own opinion,which we are lucky to have the right to in Canada, whether we pay too much tax or or not.

      Delete
  14. Hi Mark,

    I think the biggest problem with these new tax rates are the brackets in which they start. Why is the $150k bracket in Ontario not indexed for inflation? Why is $200k where the extra 4% is taxed? I don't think anyone is rich making $200k, especially if you live in a city like Toronto or Vaughan. Trudeau called the $200k+ earners "the 1%" and "millionaires". Ya I wish! I'm sure it adds up to more revenues for the gov't that way though. It's stealing from higher income earners in my view. I have to try really hard to remain positive and tell myself I'm fortunate to earn enough to still get by, even though I don't feel like the 1% or a millionaire.

    ReplyDelete
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    1. Hi Anon

      thx for your comments.

      I could not agree more. Most 1% appreciate they have done well, but if you live in a big city, being an "average" 1% does not allow you to live as you say as a millionaire.

      Delete
  15. Hi Mark, Will it still be worth using the opco/holdco structure when this change is implemented? I know some of the deferral benefits will disappear, but I guess some will remain

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    1. Hi James

      In general, yes; as long as you will leave the money in your Holdco for several years. If you take it out right away, will likely be a small cost. You will need to analyze with your accountant based on your circumstances and anticipated future dividend distributions.

      Delete
  16. The important part of the SBD is that it's just a tax deferral. I used a corporation long before I was at 1% levels so it's not just for super-high incomes. It's pretty easy to run a business where you don't get $200k/year for yourself so this might be common and all of those upper-middle-class people would be hurt by a change. When you defer taxes with the SBD you can do 3 things:

    - Invest in publicly traded assets and use the corporation like an RRSP (moreso with Canadian stocks than anything else)
    - Invest in your business to grow your income, hire people, etc
    - Smooth taxes if you would be paying a really high rate in one year but not in others

    The first one can partly circumvent RRSP limits if you have a high income or savings rate (which is not many people). It's balanced by the second one which comes down to either more taxable income later and/or more investment in the economy now. I've never had 3 full time employees but I have probably employed over 50 people. Both of those are good things.

    The third one is not a good argument against the SBD. If someone earns nothing for 2 years and then $500k in the third year, they are getting less than $200k per year and should not have to lose half of it. They would have to try to smooth it out in the future since they can't "carry forward" low earning years. The SBD is not as good as it should be for smoothing income.

    A concern that has been raised in place like The Economist is that business owners right now are choosing to limit their business so they don't pass the SBD. I have heard second hand of people who do this. They will work hard to get up to the limit and then stop there. The effect might be small since it is still a marginal gain to keep going but there are people who will say enough is enough.

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    1. Hi Anon

      Wow great analysis. I should have you write a guest blog post !

      Delete
    2. Thank you Mark, unfortunately I'm only a closet economist and wouldn't feel qualified to do that :)

      Delete
  17. The income smoothing (perhaps there is a better term - for athletes it used to be 'deferred income' but this doesn't seem to fit) that I was referring to was not in terms of some high income years and some low income years while working. It was to having many high income years while working and using the SBD to retain money in the corp that would have gone out immediately to the government in personal taxes paid. The retained money allows one to stop working much earlier than otherwise would be the case and ultimately pay less in total taxes.

    ReplyDelete
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    1. Hi Anon

      Yes, however, its all a marginal rate game. If you can retain income that you only paid 15.5% tax or even 26.5% and take it out at lower rates, you are a winner. The reality for many small biz owners is that they do have other income flows, so the $64k question is always what is the incremental marginal rate gain each year.

      Delete
  18. Agreed. I would venture that most MDs are not 'typical' small business owners and all they need to do is keep their spending in check to become big winners using the SBD.

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    1. Hi Anon

      There are a lot of professional and other kinds of businesses that are incorporated and employ one or two people. I guess the question is; is it fair that they are not allowed the SBB? I would guess u would say, it is fair.

      Delete