On the morning of July 19th, the offices of RLB came alive with action. I’m sure many other accounting firms also experienced the same sense of liveliness in the middle of what is generally a very quiet time in our industry. The culprit for our sudden burst of action… Finance Minister Bill Morneau and the proposed tax changes for 2018.
As you may have guessed, the proposed changes were not favourable ones. It isn’t often that clients frantically call when beneficial tax changes are proposed. Rather, there were some particularly disadvantageous changes presented. Although the proposal targets all small business corporations, there are two that arguably stand to affect professionals the most.
What are the new rules that will so negatively impact your current mood you may ask? The details of the two changes that have a significant effect on professionals are summarized below… I ask only that you don’t blame the messenger.
You may be one of many professionals that pay dividends or salaries to spouses and children. You look at compensation as a family unit by allocating the cash that each family member requires directly from the corporation and taking advantage of lower marginal tax brackets.
The Minister has proposed that any dividends or salaries paid to spouses or children (regardless of their age) will be subject to a reasonableness provision. Any income distributed in excess of this reasonable amount will be taxed at the highest marginal personal tax rate. So “how will the government determine which amounts are reasonable and which are not?” That is a very good question and in fact, it is one that doesn’t actually have an answer as of yet. The only details provided thus far indicate that they will consider labour contributions as they relate to salaries paid, and capital contributions as they relate to dividends. Further, they have noted that there will be additional restrictions placed on children between the ages of 18 and 25.
In other words, income splitting as you currently know it will be a thing of the past. Be prepared for the personal tax liabilities of your family unit to increase… Potentially by a significant amount.
Passive Investments in Corporations
One of the main benefits that professionals get from incorporating is that of flexibility with regards to retirement planning. They pay tax of 15% (assuming they have an income of less than $500,000) and can invest the difference within the corporation. Alternatively, if they were to draw that income from the corporation, they would pay tax at their marginal personal tax rate (up to 53.53%) and invest the difference personally. By avoiding the personal tax liability, professionals have far more money available to invest.
The Minister has proposed that income invested in passive assets (stocks, bonds, GIC’s, real estate, etc.) will now be subject to a rate equal to the highest personal tax rate. There will be no advantage to investing within a corporation. This is a significant change that will cause a great difference in the ability for professionals to save and plan for retirement. But it gets worse. It has been interpreted that all earnings of professional corporations will be considered earnings to be used for passive investment and therefore all taxed at the highest personal tax rate. In other words, professionals will get no tax deferral at all from incorporating their practices.
Other Proposed Changes
There were other changes proposed with regards to the lifetime capital gains exemption and converting income into capital gains. These rules won’t affect all professionals and are outside of the scope of this article. For additional details with regards to these changes, please contact us.
How to Prepare for the Changes
First, it is important to understand that at this time, these are proposed rules. We will need to review the final legislation before any planning is implemented. The Minister is seeking input regarding the proposals until October 2, after which time we expect additional information to be released. Our hope is that the actual rules have more leniency and flexibility than the proposed changes, specifically as they relate to the passive income rules.
The most important thing that you can do is stay informed every step of the way until the final legislation is presented. Ensure that your advisors understand what is happening and are prepared to provide planning options specific to your needs.
Understand that, changes to the proposed rules or not, there will be a significant impact on how you are currently paying tax and planning for the future. Things are going to change and you need to be prepared.
Every professional is different and will have a different set of circumstances that relate to these changes. Be mindful that the right answer will not look the same for all. As with your current tax planning, you will need a solution that is tailored to you and your circumstances.
At RLB, we are at the forefront of these changes and will be releasing information when it becomes available to us. Once the final legislation is presented, we will be available to assist with any planning necessary to ensure an efficient transition.
We’re always here to help and we happily serve our clients from our offices in Guelph, Kitchener, Fergus, and Orangeville! Please contact our team at 1-866-822-9992 to discuss any questions you may have or in order to set up a meeting to talk to you directly about the proposed changes.
Stay tuned for an information session where you will be able to ask Bill Koornstra and Leanne Radcliffe questions regarding the above changes.
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