2015 Federal Budget

The Federal Minister of Finance, Joe Oliver, yesterday presented the 2015 Federal Budget. It is a good thing Joe was giving away tax goodies, because announcing a budget with 9 days left in income tax season does not make many accountant friends :)

There was much to like in this budget. The proposed increase in the Tax-Free Savings Account ("TFSA") limit, the proposed reduction in the minimum withdrawal for Registered Retirement Income Funds ("RRIF") and the proposed reductions in small business tax rates. It will be interesting to see if these changes ever get to see the light of day.

As I am in the home stretch of tax season, I don't have the time for a detailed analysis of the budget, so I will just offer some brief comments.

TFSAs

As rumoured, the contribution limit for TFSAs will be increased from $5,500 to $10,000 per year effective January 1, 2015. However, the new limit will not be indexed. This proposed change has the potential to drastically alter the way Canadians save and plan for retirement. On Monday, since everyone has already told you how great this is, I will discuss the downside to this change.

RRIFs

The government proposes to lower the annual required withdrawal from your RRIF. Currently at age 71 the required withdrawal rate is 7.38%. The budget proposes to lower that rate to 5.28% as of January 1, 2015. Withdrawal rates will still increase every year, but instead of topping out at 20% at age 94, that cap is reached at age 95. RRIF holders who at any time in 2015 withdrew/withdraw more than the reduced 2015 minimum amount will be permitted to re-contribute the excess.

This change appeases seniors who felt they were being forced to draw more money than they required to live and takes into account the longer life expectancy of Canadians.

The Matching Penalty

Readers of this blog will know that one of my major pet peeves is the excessive 20% penalty for unreported income (that is often inadvertent or the result of lost slips in the mail) that is picked up each year by the CRA's matching program.

The penalty currently can be levied even if you owe no income tax. I.e.: If someone in Ontario fails to report a T4 slip with $10,000 of employment income and the slip has reported $4,900 of income tax deducted, they would owe no income tax, at the maximum marginal income tax rate. However, if you had failed to report income in any of the three prior years, the penalty under subsection 163(1) would be $2,000 (20% x $10,000), even though you owed no income tax and the CRA was provided this information by your employer.

The government will amend this penalty to prevent situations such as the above where there is a disproportionate penalty to the actual income tax. The budget proposes that the penalty will now only apply if a you fail to report at least $500 in income and more importantly; the penalty will now be equal to the lesser of 10% (penalty is 20%, as there is also a 10% provincial penalty) of the unreported income and 50% of the tax unpaid. Thus, in the example above, there would not be any penalty under the proposed legislation, as no tax would be owing.

T1135 Foreign Reporting Form

The government proposes to simplify the reporting requirements where the cost of a taxpayer's foreign property is less than $250,000. While this change is welcome, it falls short. Most accountants and taxpayers were hoping the form would only require reporting of foreign income earned outside of Canada and would exclude the detailed reporting required for accounts held with Canadian institutions.

Small Business Tax Cut

It is proposed the 11% Federal small business tax rate on active income for qualifying Canadian Controlled Private Corporations will be reduced by .5% annually beginning January 1, 2016 and will drop to 9% by January 1, 2019. The dividend gross-up and credit will be adjusted each year to reflect the lower corporate tax rate.

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.

Salary or Dividend? A Taxing Dilemma for Small Business Owners -2014 Update

Effective January 1, 2014 the personal income tax rate on non-eligible dividends paid by private corporations will increase. As result of this uptick in rates, the absolute income savings that were available in most provinces in 2013, when small business owners paid themselves by dividends (as opposed to salary) have been virtually eliminated.  

With these changes, the government has achieved almost perfect integration, at least in my home province of Ontario. By integration, I mean a person will be indifferent as to whether they receive a dividend or salary from a private corporation, since the ultimate income tax cost (total of both corporate and personal taxes) is exactly the same.  

Although the government has effectively removed any absolute income tax savings, a significant income tax deferral is still available where corporations earn active business income. For example, if a corporation earns active income in Ontario, the corporate tax rate is only 15.5% as opposed to a personal tax rate of 46.41% (on taxable income over $136,270). This means to the extent that a small business owner does not need all their corporate earnings to live on and can leave funds in their corporation, they are deferring 30.91% in taxes (34.03% if they are a super-tax rate taxpayer paying 49.53%).  

Jamie Golombek, the Managing Director, Tax & Estate Planning of CIBC, recently released a report titled “The Compensation Conundrum: Will it be salary or dividends?”  This is Jamie’s third report in an excellent series on owner-manager remuneration, the first two being “Rethinking RRSPs for Business Owners: Why Taking a Salary May Not Make Sense” and “Bye-bye Bonus! Why small business owners may prefer dividends over a bonus”.

The chart below, taken from Jamie’s most recent report, reflects the impact of the dividend tax changes on small business owners, who distribute their income as non-eligible dividends instead of salary; where their corporations are eligible for the $500,000 small business deduction limit (“SBD”). The absolute tax rates which Jamie denotes as tax rate (dis)-advantage reflect significant decreases from 2013 to 2014, while the tax deferral advantage is either unaffected or has grown larger in almost all provinces. For example: In Ontario, in 2013, there was an absolute tax savings of 3.21% if a small business owner received non-eligible dividends instead of salary. However, in 2014, that benefit is now only .12%. The tax deferral remains the same at 34.03%.

Tax rate (dis)advantage and tax deferral advantage

on SBD Income in 2013 and 2014

                                             2013                                                     2014

                       Tax Rate                    Tax                    Tax Rate                    Tax

                          (Dis)-                  Deferral                  (Dis)-                  Deferral

Province   advantage          Advantage          advantage          Advantage

AB                    1.17%                   25.00%                 (0.69%)                 25.00%

BC                     1.04%                   30.20%                 (0.56%)                 32.30%

MB                   0.56%                   35.40%                 (0.89%)                 35.40%

NB                    1.65%                   29.57%                   0.91%                   31.34%

NL                     1.84%                   27.30%                   0.94%                   27.30%

NS                    4.54%                   35.50%                   2.40%                   36.00%

ON                   3.21%                   34.03%                   0.12%                   34.03%

PE                   (0.18%)                 32.73%                 (1.95%)                 31.87%

QU                  (0.25%)                 30.97%                 (1.26%)                 30.97%

SK                     2.00%                   31.00%                   0.27%                   31.00%

Chart reproduced with permission from Jamie Golombek, the Managing Director, Tax & Estate Planning of CIBC from his recently released report “The Compensation Conundrum: Will it be salary or dividends?” December 2013.

For active business income (“ABI”) in excess of the $500,000 small business deduction limit (i.e.: taxable income from $500,001 upwards) the dividends distributed are considered eligible dividends and thus the absolute tax savings and tax deferral advantage are largely unaffected as noted below.

Tax rate (dis)advantage and tax deferral advantage

on ABI Income in 2013 and 2014

                                             2013                                                     2014

                       Tax Rate                    Tax                    Tax Rate                    Tax

                          (Dis)-                  Deferral                  (Dis)-                  Deferral

Province   advantage          Advantage          advantage          Advantage

AB                   (0.47%)                 14.00%                 (0.47%)                 14.00%

BC                   (1.19%)                 17.95%                 (1.42%)                 19.80%

MB                 (4.15%)                 19.40%                 (4.15%)                 19.40%

NB                    0.63%                   19.06%                 (0.13%)                 19.84%

NL                   (2.65%)                 13.30%                 (2.65%)                 13.30%

NS                   (5.88%)                 19.00%                 (5.88%)                 19.00%

ON                  (1.85%)                 23.03%                 (1.83%)                 23.03%

PE                   (3.44%)                 16.37%                 (3.44%)                 16.37%

QU                  (2.68%)                 23.07%                 (2.68%)                 23.07%

SK                   (1.11%)                 17.00%                 (1.11%)                 17.00%

Chart reproduced with permission from Jamie Golombek, the Managing Director, Tax & Estate Planning of CIBC from his recently released report “The Compensation Conundrum: Will it be salary or dividends?” December 2013.

Last January I wrote extensively about the decision of whether to pay a salary or a dividend and the benefit of accumulating a “retirement fund” inside your corporation by taking advantage of the income tax deferral. Part 1 discussed conventional wisdom in respect of the salary versus dividend issues, Part 2 demonstrated the numerical benefits of deferring income and Part 3 discussed the various issues that can impact that decision. I do not have the time or the energy to redo these posts and much of what I said is still relevant or covered by Jamie's new report. However, I would suggest there are two key changes.

If your remuneration strategy was to pay yourself a salary to the RRSP limit and then pay yourself a dividend on any amounts over the RRSP limit, the increased tax rate on non-eligible dividends means that in many provinces, there will be little to no benefit to remunerate yourself in this manner in 2014 (EHT should be considered in this analysis).

If you leave after-tax corporate funds to grow in your company, you will now pay more income tax on the eventual withdrawal of those funds, to the extent the funds are withdrawn as non-eligible dividends.

With the change to the taxation of non-eligible dividends, small business owners need to consult their accountants early in 2014 to determine if they need to consider changing the manner in which they are remunerated.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs. Please note the blog post is time sensitive and subject to changes in legislation or law.

Salary or Dividend? A Taxing Dilemma for Small Corporate Business Owners

Over the last couple years, tax professionals have questioned the traditional salary based remuneration strategy used to pay corporate small business owners. Numerically, there is hard evidence that a remuneration strategy of paying only dividends and not paying any salary results in an absolute income tax savings and potentially, greater long term retirement savings. However, foregoing a salary means you can no longer contribute to a Registered Retirement Savings Plan (“RRSP”), nor can you contribute to the Canada Pension Plan (“CPP”). In addition, although abstruse in the salary versus dividend analysis, one must somehow account for personal behavioural characteristics. A consequence of utilizing a dividend only strategy is that you “park” your retirement savings in an easily accessible and tempting location (an operating company or a holding company) and human nature being what it is, one may tend to stick a hand in the candy bowl (money bowl in this case) when there is candy (money) there for the taking.

One of the first professional advisors to advocate the use of a dividend only strategy was John Nicola of Nicola Wealth Management. John’s views were discussed in a provocative 2010 article on “Paying yourself in dividends” by David Milstead of the Globe and Mail. I say provocative (since as my friend Alison says, "I find money pretty darn sexy"), because I specifically remember several people calling me to ask my opinion on the article.

Jamie Golombek, the Managing Director, Tax & Estate Planning of CIBC was another early proponent of using a dividend only strategy, or at least considering using such a strategy. In 2010, Jamie wrote an excellent report “Rethinking RRSPs for Business Owners: Why Taking a Salary May Not Make Sense” in which he concluded it may be better to not contribute to an RRSP, but  to essentially create your own “corporate RRSP” by utilizing a dividend only strategy.

Jamie followed up a year later with another paper, this time titled “Bye-bye Bonus! Why small business owners may prefer dividends over a bonus”. In this report, Jamie concluded that a dividend remuneration strategy may be the preferred method of remuneration in many cases for small business owners.

As evidenced by the breadth and depth of Jamie’s reports, this topic is not conducive to a simple analysis. Thus, in order to make this topic more digestible, I have broken the topics on remuneration strategies for corporate small business owners into three separate blog posts:

1. Conventional Wisdom

2. Salary or Dividend - The Numbers

3. Salary or Dividend - Issues to Consider

Conventional Wisdom

So let’s review the so called “conventional wisdom” with respect to how most accountants advise or used to advise their clients to pay and/or distribute their remuneration.

For individuals who operate an active business through a corporation and whose corporation has annual taxable income of less than $500,000, most accountants generally advise or used to advise, a remuneration strategy along these lines:

1. Pay yourself a salary to maximize your RRSP contribution room for the following year (A 2013 salary of $134,833 is required to ensure you will have the ability to contribute the maximum 2014 RRSP deduction of $24,270).
2. Pay reasonable salaries to your spouse and children if they work in the business.
3. Pay dividends to the owner-manager and/or their spouse and children (if shareholders or beneficiaries of a family trust) to fund any additional living expenses not covered by salary.
4. Leave any remaining funds in your business to defer income tax on those funds. This strategy will be discussed in greater detail tomorrow.

Where a corporation has taxable income in excess of the $500,000 small business deduction (“SBD”) limit, the “conventional wisdom” used to be to pay a salary to maximize the business owners RRSP and then pay an additional bonus equal to the corporation’s taxable income in excess of the $500,000 limit (i.e. Pay a bonus to reduce the corporations taxable income to the $500,000 threshold limit at which the corporations income is taxed at a favourable low rate [15.5% in Ontario]).

However, as corporate income tax rates have declined over the last few years, “conventional wisdom” has changed with respect to paying a bonus when the corporate taxable income exceeds the $500k SBD limit. Most accountants continue to advise their clients pay a salary to maximize their RRSPs, but many now suggest their clients pay the higher general rate of corporate income tax (26.5% in Ontario) when taxable income is greater than $500,000 rather than pay the additional bonus, if the money is not needed immediately. The reason for this is to take advantage of the 19.91% income tax deferral (46.41% highest non "super tax" personal tax rate - 26.5% corporate rate in Ontario) or 23.03% deferral at the "super tax" rate. Our firm calculates that if your anticipated after-tax investment return is 3%, this strategy makes sense even if you can only leave the money in the corporation for 2 to 3 years.

For the purposes of this blog post and my two upcoming posts, I will not comment any further in regard to private corporations with taxable income greater than $500,000 as many accountants tend to agree on the above remuneration strategy.

Tomorrow, I put on my bean counter hat and throw some numbers around.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs. Please note the blog post is time sensitive and subject to changes in legislation or law.