How Does Passive Investment Income Affect Your Corporate Income Tax Rates?
When it comes to Canadian tax regulations, we are used to the fact that we commonly need to pivot our strategies with new regulations that are constantly introduced. While stability is appreciated, we’ve learned that it’s more important to be adaptable. With the stricter taxation rules issued for Canadian businesses and their passive income earnings, it’s important to grasp where the limits lie, and how to honour them while earning sufficient wealth. This is what helps Canadian-controlled private corporation leaders thrive in this country.
As we focus on the teetering regulations for CCPCs, we must first look at the Small Business Deduction, which has been tweaked over the last few years. The frequent changes have been requiring tax experts to develop new plans to help corporations reduce their annual tax rates. With the changes brought on by the new Small Business Deduction limits for Canadian-controlled private corporations, all factors come into play for finding new solutions for our clients who are CCPC leaders. One of the significant influencers that could impact SBD eligibility or improve annual topics is your passive income.
With this article, we will guide you by understanding how the Small Business Deductions changes could leave you struggling with higher tax rates and how your passive income could help if you approach it correctly.
Understanding Canadian-Controlled Private Corporation Taxation Benefits and Regulations
With the Small Business Deduction benefit, your company could earn a far lower tax rate on your annual income taxes. You are only eligible for this benefit as a Canadian-controlled private corporation, meaning 51% of ownership belongs to Canadian residents.
In the past, the Small Business Deduction only accounted for your active income. The criteria were far less limiting, allowing for more CCPCs to take advantage. The government then became concerned, however, due to multiplied benefit claims. Before, companies profiting from passive income investments, like partnerships with other companies, were not considered to be exceeding the small business income limits. So, one CCPC owner who started two branch companies was saving taxes on three sources of the total income, costing the federal government thousands in tax earnings. That’s what led to the stricter regulations that ensued.
Now, with stricter regulation as of 2019 onward, your passive income could impact your eligibility for the lower tax rates from the Small Business Deduction. Suppose your company is invested in a partnership with another corporation and receiving profits that make your annual income more than $15 million. In that case, you are no longer able to claim the SBD. In fact, you could end up being penalized for profiting more than $50,000 from your passive income or Adjusted Aggregate Investment Income source, leaving you needing to pay a tax rate of up to 26% on your annual income.
Breaking It Down Further
As of 2019, a Canadian-controlled private corporation could claim up to $500,000 of their profits to be taxed at a lower rate of 13.5%. However, they are only permitted to earn $50 000 in passive income for optimal taxation results. For every dollar of passive income above the limit earned, your small business dedication would decrease by $5, leaving you with a lower Small Business Deduction. The limits are far stricter; and when exceeded, your tax rates will be much higher than before 2019. In fact, you could end up paying up to $80,000 more annually.
So how can you prevent paying a 130.67% tax rate on passive income?
Your Canadian-Controlled Private Corporation Passive Income Strategies
To limit the thousands of dollars in taxes you may need to pay with the stricter taxation rules, you need to determine the costs vs. benefits of earning more than $50,000 in passive income. You’ll also want to look at your passive income investments and learn how they are observed by the government tax-wise.
Here are some strategies to help you maintain your eligibility for the Canadian Small Business Deduction while continuing earning profitable passive income:
Dividends vs. Bonus Offerings
Many Canadian-Controlled Private Corporation leaders prefer to pay themselves or their employees an annual bonus. However, you may not realize that you and your business could be saving more on taxes with provincial deferrals available. Bonuses are taxed personally, meaning they do not affect your eligibility for your CCPC’s tax deferrals. According to CIBC data, the dividend strategy is the best move for earning you an impressive tax break in the long run. You could make up to $34,440 more from your dividends than offering yourself and your workers bonuses or personal investment opportunities.
Individual Pension Plans
The Individual Pension Plan is an intensified version of RRSPs. It offers a 2% Defined Benefit formula while also boosting your retirement savings up to 65% more than your RRSP savings. Better yet, your IPP could help to decrease your corporate taxes with little risk involved in the investment.
With the IPP, you are investing in a passive income that will benefit you in the future. Your corporation would be paying into your IPPs, but since the income earned isn’t returned to the business, this investment is not taxable for the corporation.
Corporate-Owned Life Insurance
Another investment that would be exempt from the SBD taxation limitations but profit you and your future generations would be a corporate-owned life insurance policy. This investment does not lead to further capital gains for the business. Therefore, it would not contribute to the $50,000 passive income limit. The income earned from the policy is exempt from your company’s annual revenue, which would be a worthy investment with high rewards, especially for your loved ones and family members.
Maximize Contributions to Registered Retirement Savings Plans
By investing in RRSPs and TFSAs for yourself and your employees, you are instead considered as withdrawing funds to commit to personal investments rather than contributing to our company profits. In doing this, you would be required to turn your corporate income into a personal salary to be invested in your RRSP. This would influence your personal taxes. However, your RRSP would be exempt. Overall you’d be investing in yourself and lowering your corporate tax rate by limiting your business’ passive income.
Work With Experts Who Will Benefit Your Canadian-Controlled Private Corporation
Our team at Global Solutions is equipped with experts who understand wealth management and corporate tax management from decades of experience. We will advise you on the best strategies to manage your income and avoid heavy tax penalties while honouring regulations. Let us walk you through how you can remain within the limits that make you eligible for the Small Business Deduction (if you earn less than $15 million) by organizing your passive income.