TAX PLANNING – INCOME SPLITTING
A Canadian taxpayer’s income tax bracket and therefore the income tax liability depends on the absolute amount of the taxpayer’s income because the higher theincome the higher the income tax bracket and the percentage of income tax paid. Income splitting is a tax planning strategy whereby one taxpayer transfers a portion of his/her own income to another taxpayer who is taxed at a lower tax rate. There are various income splitting techniques that can be used.
INCOME SPLITTING TAX PLANNING- SALARIES
A small business owner can often income split with a spouse by employing the spouse in the business as a T4 employee or by having the spouse own shares of the corporation and receive dividends. Any salary paid must be reasonable and supported by the actual work done. A written employment agreement is very advisable. If the spouse or children are going to own shares of the business, care must be taken to avoid the income tax attribution rules that attribute income or capital gains on the property back to the spouse who originally owned the assets.
Income Splitting Tax Planning – Window Closing On Low Rate Loans
The federal prescribed interest rate for income tax for the fourth quarter of 2013 will increase to 2%. As the rate is presently 1%, a tax planning opportunity exists provided all planning is in place prior to October 1,2013. If a higher income spouse lends funds to a lower-income spouse and charges the prescribed interest rate throughout the period in which the loan is outstanding, all income and capital gains, net of the interest paid, is taxed in the hands of the lower income spouse. The higher income spouse who made the loan would only include interest based on the prescribed interest rate at the time of advancing the loan. A written loan agreement should be entered into between the spouses which provides that the interest on the loan be paid no later than January 30th of each year, and the interest should in fact be paid. Furthermore, any loans that may have been entered into previously at a higher rate should be repaid and a new written loan agreement entered into. The loan technique can be used post 2013 but the interest rate will be higher.
Maximize CCA (Tax Depreciation) - Buy Capital Assets Just Before Business Year End
If you purchase business capital assets immediately before your business year end, you can claim capital cost allowance (income tax depreciation) of 50% of the capital cost allowance rate in that year. If you buy the asset just after the year end then you claim that same rate, but only in the next year, postponing your income tax deduction by one year.
Sell Business Capital Assets After Business Year End
By disposing of capital assets (business property) after the business taxation year end you defers income taxes on the capital gain and depreciation recapture until the next year end.
Consider Income Tax Effects Of Dividends Vs. Salary/Bonus
Owners of a business should consider using a mix of salary or bonus and dividends to minimize overall taxes for the individual shareholder - owner and the corporation. This should be done every year and requires income tax planning and calculations done by the corporation’s accountant.
Consider Setting up a Private Pension Plan
Contributions to employees’ registered pension plans, including plans for the shareholders, are tax deductible to the company as business expenses. The employer’s pension contributions to the RPP are not taxable for the employees. Private pension plans can be set up for owners and managers instead of a Registered Retirement Savings Plan and are an effective tax planning tool.
Repay Shareholder Loans Within 2 Corporate Year Ends
Shareholders and owners can always take funds from the business as shareholder loans or draws, but there are tax implications and rules that have to be followed. If the shareholder loan amount is repaid within two business year ends (ie. by the end of the following business year), the amount of the loan is not deemed to be a taxable benefit to the shareholder/owner (borrower). If it is outstanding for 2 corporate year ends then subsection 15(2) of the Income Tax Act includes the full amount in the income of the shareholder. However, if the shareholder did not pay interest on the loan, or paid interest 30 or more days after the end of the taxation year, then the shareholder is deemed to have received a taxable benefit for the unpaid interest.