New Budget on Passive Income – A bittersweet Outcome

As much as I disagree with Ottawa on their point of view of having “an unfair tax advantage” for small business, I am glad to see that they listened to the feedback and found a cleaner and simpler solution to close what they consider to be a loophole for small corporations, which include professional corporation (MPC).
 
What is?
Currently, most MPC are enjoying the small business tax rate of 15% (Ontario) by keeping the corporate income under $500,000.  This $500,000 is called the Small Business Deduction Limit.  Even if your corporation bills over $500,000, your accountant would use salary to reduce (called bonusing down) the corporate income to $500,000, so your MPC does not get bumped up to the regular business tax rate of 26.5% (Ontario).
  
What will be?
With the new budget, this Small Business Deduction Limit is reduced by $5 for every $1 of passive income over the $50,000 threshold.  Once your passive income reaches $150,000, your MPC will completely lose its small business deduction limit of $500,000 ($100,000 x 5).
In my experience, most MPC do not have a $500,000 income especially when most physicians are now on salary to accumulate RRSP contribution room.  For example, if you bill $400,000 per year and take $150,000 of salary, your MPC will only have a $250,000 of taxable income. That means your MPC will not be affected by this change until your passive income reaches $100,000 (or $2 mln in savings at 5% return).  Here is a table to illustrate the relationship between MPC income, Passive income and Small Business Deduction Limit.

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What to do?
Of the 23 financial plans we completed for clients in the past two months, only a couple of physician would accumulate over $3 mln  in the corporation within 10 years of practice.  Most will reach their passive income threshold after 20 years assuming that they would maximize their personal savings (RRSP TFSA RESP) and aggressively pay off their mortgage over that period. 
Until accountants and lawyers come up with other options to mitigate this tax impact, we continue to advise physicians to maximize their RRSP and TFSA so that less money would accumulate in the corporation.  Whole Life is also a Must in the corporation going forward to tax shelter investments as the growth within a Whole Life plan will not count towards passive income. 
 
Please feel free to reach out to us if you have any questions on the budget and how the change may affect you.
 

Friendly reminders:

  • Speak to your accountant about switching to salary if you are still on dividends
  • Contact us if you want to include Whole Life insurance in your Corporate investment portfolio. Whole Life insurance works better if you start at a younger age.

Revisiting Salary after the Tax Change

The income splitting tax change announcement made right before Christmas was a big surprise for most accountants and advisors.  Many had been burning the midnight oil throughout the holiday and into the New Year trying to help their clients prepare for the change that was made effective January 1st, 2018.   

Once incorporated, physicians would need to choose between salary and dividend when they take money out of the corporation.  In more recent years, more physicians opt for dividends over salary due to its simplicity of not having to remit taxes and CPP (Canada Pension Plan) every month.  The net after-tax dollar amount is also higher when you do not need to give the government $5,000 a year for storage until you retire.  (I used the word “storage” because you are only getting 1 to 2% return on your CPP contributions at best).  In my opinion, the real benefit of salary is to build your RRSP contribution room.

However, the scale definitely tips over to salary a lot more for 2018 for a couple of reasons:

1.       The dividend tax rate is higher for 2018.  Wait!  Didn’t the government lower the corporate tax rate for 2018?  Yes, they did but they also increased the dividend rate so you do not get to take advantage of drawing dividends.  In fact, you are paying slightly more taxes for 2018 than 2017 when withdrawing dividends.  Here is an article from PWC explaining this tax change.

2.       The last update from government on raising taxes on passive income inside corporations was introducing a $50,000 threshold.  So, instead of taxing all passive income at a higher rate, only passive income over $50,000 will be taxed at a higher rate.  Having more RRSP contribution room will allow you to shift more of your savings from the corporation to your RRSP so that your corporation will not reach the $50,000 passive threshold as quickly.  This change has not yet been put in place but we will probably hear more about this in the coming months.

It is worth having a discussion with your accountant and advisor to see if your dividend/salary composition should remain the same for 2018.  If you are switching to salary and RRSP, you should also learn more about the drawbacks of RRSP such as minimum withdrawals requirement at age 71 and taxation at death.

 

Reminders:

It is not too late to declare additional dividends for 2017.  Since 2017 is the last year you can distribute dividend a non-voting shareholder without justification, you should see if it makes sense to top up the dividend to a higher tax bracket for your spouse and/or parents.

Further to the last point, you may also increase the payout to your spouse so he/she can effectively use his/her RRSP contribution room at a higher tax bracket for 2017.

Rising Interest Rates - How should you prepare for it?

Rising Interest Rates - How should you prepare for it?

After years of historic low interest rate, Bank of Canada has finally raised the interest rates twice in three months and hinted that this is not the end of it.  If you are carrying a line of credit or variable mortgage, your monthly expense towards debt servicing has just increased by 18%.  To put this into different perspective, if your current cash-flow will allow you to pay off your debt in 15 years, it will now take 15 years and 8 months to be debt free.  Here are some steps to manage your debt:

Tax change is inevitable, how can you prepare for it?

Tax change is inevitable, how can you prepare for it?

On July 18th, the government proposed to make fundamental changes on income splitting and tax deferral for professional corporation.  You may have received emails from multiple sources regarding this change.  The purpose of this article is not to repeat what has been told.  We believe there are planning opportunities for some physicians and dentists so they can be better prepared for this change.
 

Canada Life Disability Insurance's Achilles Heel

Residual Benefits is a built-in feature for all disability plans.  It provides a partial benefit as the physician recovers from a disability and return to work on a modified (reduced) schedule.  Most disability claims begin with full benefits payout while the physician is unable to work in any capacity.  As she recovers, she would ease back to work on a modified schedule.  At that point, the disability benefit amount will be calculated as follows:

The Disability Insurance that pays forever…

There are four insurance companies offering disability insurance to physicians at the moment.  They are Canada Life, Great-West Life (GWL), Manulife and RBC.  Although the RBC plan is the most popular option for medical students due to its non medical underwriting requirement, some students wonder if they should consider other options given that they are healthy and should have no problem passing the medical.

What does tax deduction really mean to you?

Understanding how tax deductions and tax credits work would help guide many of your financial decisions.  When physicians come to me with a specific question, they usually come with a few options in mind and only require some clarifications.  More often than not, they would know the answers to these questions if they understand how tax deductions and tax credits work.