You may (or may not) have heard that the Liberal government proposed some significant tax changes this past summer that could significantly impact small business owners... and then reversed course or modified some of those proposals. With all of the back-and-forth and commentary going around, we thought we should take a minute to get you up to speed on the essential aspects of where we're at today, and what tomorrow’s tax landscape looks like.
What's changing for small business owners?
Here's the short version:
Dividends to kids under 25 - these will now be subject to tax at the top marginal tax rate (effective in 2018) unless they’re reasonable based on the amount the kids have invested in the business or the amount that they actually work in the business. What does reasonable actually mean? Well, that’s unknown at this point, because there is currently no test or criteria to determine this, so we’ll wait for further clarification on that one. Generally speaking, if your under-25 kids don't work regularly in the business or have significant cash of their own to invest in the business, you can probably forget about paying them any significant dividends.
Dividends to other family members - these will also be subject to a reasonability test which looks at the person’s actual contributions to the company either by cash investment or by working hours or both. And no, a job description will not suffice - CRA can ask for proof such as reports prepared by the person, copies of their correspondence with clients or staff, etc., and dividends considered unreasonable will be subject to tax at the top rate (nearly 50% in BC for 2018).
Lifetime capital gains exemption access - for those of you not familiar with the LCGE, it is currently $835,714 that each person can receive effectively tax-free when you sell qualified small business shares, or $1,000,000 if you’re selling qualified farm or fishing property. Currently, if those shares or property are held in a family trust at the time of a sale for example, then it may be possible to claim an exemption for each person who is a beneficiary of the trust, which could effectively multiply the exemptions by the number of family members inside a trust, including minor children under 18 years of age. Initially, the government had proposed measures to signifiantly limit this type of tax planning. However, they have now indicated that they will not move forward with those changes.
Passive income - new rules to tax passive income inside corporations coming soon...but we don’t know when or exactly what they will be. Passive income means income from property rather than active business, so income from investments and rental property would fall under this category. Originally, the government proposed some ideas for taxing this type of income, which could result in total tax of 73% by the time it gets to your pocket; a punitive tax to say the least. Since then, they’ve reversed course a bit and said that the income from first million dollars (approx. $50,000 annually) won’t be subject to this tax, and that there will be some grandfathering for existing investments. At this point, however, no draft legislation has been released, so we will still wait to find out what this proposed tax change will truly look like. Keep in mind that these changes apply to passive investments held inside corporations only, not personally.
Corporate tax rates - finally, some good news! These rates are getting lowered for small businesses, down to 10% in 2018 and 9% starting in 2019 (keep in mind these are only federal rates; you still have to pay provincial corporate tax on top of that). For small business corporations in B.C., this will mean paying a total 12% combined corporate tax on taxable income from active business (up to $500,000) starting in 2018, and an 11% combined rate thereafter.
Update: more clarification and some changes announced December 13th. Find the details here: http://business.financialpost.com/personal-finance/taxes/senate-committee-says-liberal-tax-changes-should-be-scrapped-or-postponed
While this list doesn’t cover everything, these are the changes that will have the biggest impact on most small business owners. Want to know more? Call us today at 604-885-4111.
As always, this article is intended for general informational purposes only and is not comprehensive; you should always seek tax advice specific to your situation.