We recently wrote an article showing how incorporated mid-career physicians, for example, may be affected by the proposed passive investment income rules. The larger the investment assets are in a Canadian Controlled Private Corporation (CCPC), the more the larger the potential investment income. For example, if $1,000,000 are invested within a corporation earning 5% in interest, the corporation would have $50,000 of passive investment income. If this same corporation had $3,000,000 invested, one would expect that the corporation would also be making three times more in passive investment income (i.e. $150,000).
When investment income exceeds $50,000, it negatively reduces the SBD of a corporation down from $500,000 (see article Article Draft: Impact of 2018 Federal Budget on CCPC’s) for a detailed explanation of how this works.
While it is well known that no reductions to the SBD will begin until 2019, few realize that the reduction will be calculated based on 2018 passive investment income. It is important for this reason to start sheltering income as of today!
There are a few planning strategies that are available to CCPCs and business owners.
- Tax Effectively Allocate Your Investments
- Not all investment income is taxed equally. Tax effective allocation of investments between account types has never been more important. If an individual has investments in corporate investment accounts, Registered Retirement Savings Plans (RRSPs), Tax Free Savings Accounts (TFSA) and Non-Registered Accounts, smartly allocating different investments based on their tax treatment can impact the amount of active business income realized in a corporation.
- For example, only 50% of capital gains are taxed and therefore only 50% of capital gains are considered passive investment income. It would be preferential to have capital gains over interest income (100% taxable) in a corporation.
- Maximize Registered Accounts.
- Business owners and incorporated professionals might have preferred dividends over salary in the past. However, one way to slow down the impact of the changes on passive investments in CCPC’s is to pay a large enough salary so as to maximize the ability to contribute to an RRSPs (unlike salary, dividends do not create RRSP room). By having the ability to invest in RRSPs, individuals have greater flexibility to tax-effectively allocated investments. Investment income earned in an RRSP does not count towards the corporate passive investment income as it is held personally.
- Another option that presents itself when taking salary out of a corporation is an individual pension plan (IPP). An IPP is similar to a defined benefit pension plan that can be offered to nurses, teachers or to employees of larger companies. It is offered to business owners and can potentially shelter significant assets (similarly to an RRSP). Please refer to our article for more detail on IPPs and why they might be worth re-consideration IPPs: Even More Important With Recent Changes.
- Corporately Owned Life Insurance
- Corporations can own life insurance and may be able to invest after-tax dollars in corporately owned life insurance. The funds that are invested in life insurance policies are tax deferred and so do not contribute to passive investment income. These funds can sometimes be considered available for retirement through lending arrangements. It is best to consult your financial planner and your tax advisor if considering such policies.
For more information on strategies to optimize your wealth plan, please speak with your Tall Oak Raymond James advisor.
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