As a business owner, you may have substantial personal assets invested in your business in addition to the long term commitment you have made to your business and its employees. This can have significant implications, not only for you and your business but also for your family’s financial security.
To protect your investments, both business and personal, your business strategy should include carefully structured tax and estate planning components to ensure you have organized your assets in the most tax effective manner and utilized the tax planning strategies that are available for the benefit of your business and your family.
There are several income splitting strategies available to owners of private corporations in Canada that may benefit you and your family.
Personal tax planning
There are several income-splitting strategies available to owners of private corporations in Canada that may benefit you and your family. They include:
Income splitting by paying a salary to family members - Consider income splitting with lower-income family members by employing them in the corporation and paying them a reasonable salary based on the services they perform. The salary they receive will also create Registered Retirement Savings Plan (RRSP) contribution room for them and generate Canada Pension Plan (CPP)/Quebec Pension Plan (QPP) pensionable earnings. Note that the Organize your business assets in the most tax-efficient manner There are several income splitting strategies available to owners of private corporations in Canada that may benefit you and your family. tax rules provide a disincentive to paying a salary or bonus that exceeds the value of the services rendered.
Income splitting by paying dividends to adult family members - If you have an active corporation, you may be able to transfer some or all of the future growth of the business to the next generation of your family using an estate freeze with a family trust. This strategy allows you to income split by paying dividends from the corporation to your spouse and adult children. If they have no other income, they may be able to receive substantial tax-free dividends from the corporation (the amount varies depending on the type of dividend and the family member’s province/ territory of residence). There are rules that will cause the dividends paid to your family members to be taxed at the top marginal tax rate. Therefore, it is important to speak with a qualified tax advisor if you are contemplating this strategy.
Multiplying the capital gains exemption - It is possible to multiply the capital gains exemption available to you and your family on the sale of the qualifying shares of your business. This could significantly increase the family’s after-tax assets following the sale. One way to do this is by having your operating company owned by a family trust where your family members are the beneficiaries of the trust. When you sell the qualifying shares owned by the trust, the resulting capital gains can be allocated to each beneficiary and they can each claim their capital gains exemption. For example, a family of four can claim four times the capital gains exemption versus the business owner, who can claim the capital gains exemption only once. This results in additional tax savings for the family. Keep in mind that certain rules restrict the ability to claim the capital gains exemption with respect to minors and non-arm’s length sales.
You may also wish to consider some potential estate planning opportunities. Freezing the value of your estate can help you limit your tax liability on death. You can also defer capital gains on the future growth of the business and attribute them to the next generation while retaining control of the business.
It is important to note that if you wish to use a family member’s capital gains exemption on the sale of your business, the family member will be entitled to some of the sale proceeds. The funds will no longer belong to you as the business owner, so ensure this is a practical strategy for your circumstances.
Tax planning for your business
If you’re the owner of a private Canadian corporation earning active business income, consider whether the following strategies would work for your business:
Setting up a retirement plan - Consider setting up an Individual Pension Plan (IPP) as part of your retirement plan. An IPP is a defined benefit pension plan that, in certain situations, provides greater annual contribution limits than an RRSP. IPP contributions increase with the age of the plan holder.
Contributions to the IPP are tax deductible for your corporation. The investments in the IPP grow on a tax-deferred basis and are only taxable when you start withdrawing funds from the IPP.
If investment earnings in the plan are lower than expected, you may be able to make additional contributions. IPP assets may offer creditor protection and typically suit business owners who are age 40 or older and earn significant employment income. This means that you will need to draw a salary from your business.
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By maintaining your operating company’s status as a QSBC, when you eventually sell its shares, you may be able to take advantage of the capital gains exemption. This exemption is available to individual shareholders of active Canadian private corporations and can represent a sizable tax saving.
Maintain qualified small business corporation (QSBC) status - When you sell the shares of your corporation, you may be able to take advantage of the capital gains exemption. This exemption is available to individual shareholders of active Canadian private corporations and can represent sizable tax savings.
To qualify for the exemption, ensure your corporation meets the QSBC status. Certain corporate structures may make this easier. Since surplus assets may limit your ability to claim the exemption, you may want to transfer non-business investments to a holding company. This can “purify” the operating company and reduce the accumulation of non-qualifying assets.
Earning Canadian dividend income in a corporation - Canadian source dividends from publicly traded securities are generally subject to a flat refundable corporate tax. If you are earning Canadian public company dividends in a corporation, consider paying out a dividend in the same year if you will be paying taxes at a lower tax rate personally as the corporation will receive a refund on the taxes it paid.
Life insurance as a tax-exempt investment in the corporation - If you have surplus funds accumulating in your corporation, you may be taxed at a higher rate on the investment income earned in the corporation than if you earned this income personally (depending on the province/territory). There may also be a double taxation on your death if you own a corporation. Tax planning solutions are available to help you address this problem.
A corporate-owned tax-exempt life insurance policy can provide income protection for survivors, fund buy-sell agreements or pay capital gains tax on death. Life insurance premiums are generally not tax deductible, but it can be advantageous to purchase life insurance through a corporation rather than personally. The corporation’s surplus assets can be invested in the insurance policy, grow on a tax-sheltered basis during your lifetime, provide a supplementary source of retirement income and be paid to your beneficiaries as a tax-free death benefit.
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for more information about strategies that may reduce your personal and corporate taxes.
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Business planning quick tip
If you own a private Canadian corporation, you may be able to use several strategies to reduce taxes. These tax strategies include income splitting with lower-income family members, maintaining your small business tax status if you are planning to sell the shares of your corporation and investing surplus assets in a tax-exempt insurance policy and other tax-efficient investments.