Tax planning should be a year-round affair. But as year-end approaches, now is a particularly good time to review your personal finances and take advantage of any tax planning opportunities that may be available to you before the December 31st deadline.
As we enter the final weeks of 2022, here are some tax tips that business owners and employers should consider.
A corporation may distribute its income to you (as a shareholder and employee of the corporation) either as salary or dividends.
If corporate income is paid to you as salary (or bonus), the corporation (employer) can claim an income tax deduction for the salary (and applicable payroll taxes), which reduces its taxable income. You include the salary in your taxable income and pay tax at personal, graduated tax rates.
As an alternative to distributing income as salary, the corporation can pay tax on its corporate income. In the year the income is earned or a future year, the corporation can distribute its after-tax corporate income to you as dividends. You generally pay no tax on capital dividends and pay a lower tax rate (than for salary) on eligible and non-eligible dividends due to the dividend tax credit (DTC), which is meant to compensate for taxes paid by the corporation.
So how do you choose between salary and dividends?
As a general rule of thumb, if you need to withdraw funds from your corporation, perhaps to pay personal expenses, then consider withdrawing salary to create RRSP contribution room. Receiving a salary of up to $171,000 in 2022 would create RRSP contribution room in 2023 of up to $30,780 (the 2023 maximum).
If you do not need to withdraw funds from your corporation, you may still wish to withdraw sufficient funds to maximize contributions to RRSPs and TFSAs.
Finally, consider leaving any remaining funds in your corporation to benefit from the significant tax deferral, which may provide more investment income in the long run than personal investing in non-registered plans. You may then distribute the company’s income as dividends in a future year.
Tax-free dividends
If your corporation has unrealized losses in its investment portfolio, it’s worth checking to see if there is a positive balance in your corporation’s capital dividend account (CDA) before engaging in any tax-loss selling, as discussed above. The CDA is a notional account that tracks the non-taxable portion of capital gains, among other things. Dividends may be designated as capital dividends, which are generally tax-free to the shareholder if they do not exceed the balance of the CDA. Net capital losses will decrease the CDA and will, therefore, reduce (or possibly even eliminate) the capital dividends that may be paid. Prior to realizing any capital losses, consider paying out any capital dividends to eliminate any positive balance in the CDA.
Loss consolidation
You may have more than one corporation within a corporate group. One (or more) of these companies may be profitable (“Profitco”), and one (or more) may be suffering losses (“Lossco”) at this time. The CRA has generally permitted the consolidation of losses within a related group through a variety of methods. For example, Profitco may subscribe for shares of Lossco, which in turn makes a loan to Profitco. Interest payments on the loan will reduce the taxable income of Profitco, and the taxable interest income received by Lossco will be offset by its losses.
As corporate reorganizations are complex, tax and legal advisors should be consulted before implementing any loss consolidation transactions.
Business transition planning
If you’re thinking about transitioning your business to new owners and you believe that your business has recently dropped in value, you may want to explore some of the planning considerations, including an estate freeze or refreeze.
The “tax on split income” (TOSI) rules can apply where an individual receives a dividend or interest income from a corporation or realizes a capital gain, and a related individual is either actively engaged in the business of the corporation or holds a significant amount of equity (with at least 10% of the value) in the corporation.
When the TOSI rules apply, dividends are taxed at the highest marginal rate.
If your private corporation has other shareholders, such as your spouse, partner, children, or other relatives shareholders, review the possible impact of the TOSI rules with your tax and legal advisors before paying dividends to these individuals in 2022.
The first $500,000 of active business income in a Canadian-Controlled Private Corporation (CCPC) generally qualifies for the small business deduction (SBD), which reduces the corporate tax rate by 12 to 21 percentage points in 2022, depending on the province or territory. This means there may be significantly more after-tax income in your corporation for investment when the SBD is available.
New rules were introduced effective in 2019 which affected the amount of income that is eligible for the federal SBD. The SBD is generally reduced by $5 for each $1 of passive income over $50,000 in the previous year. Once passive income reaches $150,000 in the previous year, none of the current year’s business income may be eligible for the lower tax rates.
If your corporation is approaching the $50,000 limit for passive income in 2022, consider a “buy and hold” strategy to defer capital gains. Also, consider whether an Individual Pension Plan or corporately owned exempt life insurance may be appropriate, as income earned within these plans will not be treated as passive income.
You may also wish to withdraw sufficient salary from your private corporation by December 31st to maximize contributions to RRSPs and TFSAs. These registered investment plans may offer benefits beyond those available with corporate investments.
Reasonable salaries may also be paid to family members who work in the business to allow them to make contributions to RRSPs and TFSAs. This will also reduce future investment income within the corporation, perhaps preserving access to the SBD, as discussed above.
If you borrow money from your corporation at low or no interest, you are generally considered to have received a taxable benefit from the corporation equal to the CRA’s current 3% prescribed interest rate, minus any interest you actually pay during the year or within 30 days after the end of the year.
Unless the loan is for a limited number of qualified purposes, it will be included in your income for tax purposes in the year it was advanced unless you repay it within one year after the end of the company’s taxation year in which the loan was made.
For example, if your company with a December 31st year-end loaned you funds on October 1, 2021, you must repay the loan by December 31, 2022. Otherwise, the loan will generally be considered income that is taxable in your 2021 personal tax return (i.e., the year the funds were loaned to you).
If you claim federal or provincial tax credits for apprentices and co-op students you employ, you should review these credits to determine whether there have been any recent changes or enhancements. These credits, which can help boost your business’s cash flow, vary by province and can change from year to year. If you don’t claim such credits, it’s worth the time to check whether you qualify.
Don’t forget to gather proper documentation to support your claim for these credits (such as apprenticeship training agreements) as soon as possible, because it can be difficult to obtain them after apprentices have left your employ.
If you would like more information on this topic, please contact a member of the Empire CPA team by filling out the contact form below.
Canadian and foreign tax laws are complex and have a tendency to change on a frequent basis. As such, the content published above is believed to be accurate as of the date of this post. Before implementing any tax planning, please seek professional advice from a qualified tax professional. Empire, Chartered Professional Accountants will not accept any liability for any tax ramifications that may result from acting based on the information contained above.
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