2018 Tax Changes & common questions

2018 Tax Changes and common questions

Three common questions in light of the new tax rules (TOSI and passive income rules)

A lot has changed in the tax and accounting world over the last year or so. I’ve been mulling over the 2018 tax changes, trying to decipher them and understand how they truly impact the taxpayer, both you and me. One thought that consistency lingers over my head is how much it will truly cost a business owner who has been accumulating savings within their corporation, with the hopes that one day they will be able to taste the wine they’ve harvested for several years.

Unfortunately, the new tax rules are similar to a hurricane that destroys villages and towns that businesses or taxpayers have worked hard to build. Although there are carve outs for those over 65, the remaining age groups are left with rules that are difficult to comprehend, difficult to practically carry through and difficult to plan for. Until tax court cases and precedence is set, the true impact of these rules will not be known.

In light of these new rules, I’ve noticed three common questions that clients ask me:

1. Can I still give my spouse or parents some dividends if they are involved in the business? If so, how much can I give them?
2. I’m thinking of buying real estate, should I buy the property personally or in a corporation?
3. I’m a young professional, does it still make sense for me to incorporate?

The answer to each of these questions is, ‘it depends.’ The only part that is clear with the new tax changes is that there is no right or wrong answer. Each person’s situation needs to be examined individually. Let’s answer these questions with this thought:

1. Can I still give my spouse or parents some dividends if they are involved in the business? If so, how much can I give them?

The new TOSI (tax on split income) rules are complicated. The general presumption is that a taxpayer is subject to TOSI, unless they can find an exception.

Generally if a spouse or parent is involved in the business and are over 24 years, they can be paid a dividend based on a “reasonable return.” If the spouse or common law partner is working for at least an average of 20 hours per week during the portion of the year in which the business operates, then they can be paid a dividend without taking into account the “reasonable return.”

Practically, a spouse may work on average more than 20 hours a week to assist their partner in their business operations. The tricky part is proving this and keeping records. It is now important to keep time-sheets, emails going back and forth documenting what the individual is involved in, to what capacity and what exactly they do. All the dinner table conversations now have to be documented to prove that the spouse or parent is “actively engaged in a regular, continuous and substantial basis.”

My thought is that spouses/parents often carry out mundane functions and tasks which a busy professional or business owner may not be aware of. To sit down and determine how each person contributes to the business and to document it, seems ridiculous. The only positive aspect of is that perhaps now spouses may have more appreciation for each other – or maybe lack of!

2. I’m thinking of buying real estate, should I buy the property personally or in a corporation?

The answer is, ‘it depends.’ With the new passive income rules in particular, it is not as advantageous to hold passive assets in a corporation. There are several factors which come into play here:
– How long you intend on holding the property?
– Intention of holding the property?
– What would you do with the funds if you had a short term profit?
– What is your personal taxable bracket?
– Where is the source of the funds coming from?

The answer to the question, if there is one, will depend on a combination of factors.

For example, if an individual is an incorporated professional and has a real estate corporation (residential property), it is reasonable to assume that the real estate corporation was funded by the savings in the professional corporation. Generally an Ontario professional corporation would pay tax at the Small business tax rate of 13.5% (assuming it is a CCPC earning active business income) on income up to $500,000. The new passive income rules essentially imply that if and when the real estate property is sold and a capital gain is realized, the tax rate of the professional corporation will be increased (if the taxable gain is more than $50,000). Therefore, not only will you be paying the capital gain tax in the holding company (which you would ordinarily paid anyways), but your small business tax rate in your professional corporation would not be 13.5% (if passive is more than $150,000, the professional corporation would pay taxes at 26.5%). That’s a big difference!

On the contrary, if an individual is in the highest personal taxable bracket is contemplating purchasing real estate through a corporation, the tax rate realistically will not be much different if they are considering short term sale. If they intend on holding the property for a longer period of time and perhaps having years where they will not be at the highest personal taxable bracket, then it may make sense for them to incorporate.

There are a lot of variable factors and there is likely no right answer. However, as I tell my kids, often times we just have to make a decision based on our best estimate of the facts and situation.

3. I’m a young professional, does it still make sense for me to incorporate?

Again, the answer is, “it depends.” I always ask the following follow-up questions to this question:
– How much do you anticipate on earning gross and net?
– How much do you anticipate you will need to take out and how much can you leave in the corporation?
– Have you purchased your first home yet?
– Have you maximized on your RRSP deductions?

One of the biggest factors to consider is residual income. If a taxpayer needs to take all the monies earned in the corporation out to fund their personal expenses, it may not make sense to incorporate. The benefits of the incorporation start from when a taxpayer earns more than their personal expenditures and so could benefit from the difference in the personal and corporate tax rate. It is important to remember that this should be looked at frequently as situation and circumstances change.
The other factor to consider is if the taxpayer has purchased their first home yet as likely they will need all the funds to assist with the down payment whenever they do purchase their home. Same applies if they have significant student loan that needs to be paid.
There are other benefits of incorporating which should be looked at on a case by case basis. Young professional often do incorporate because they are able to take advantage of good tax planning.

My approach has always been to take these rules head on – approach each change separately for each client. However, more often than I want, the approach or answer to questions is, “it depends.” Although I despise giving this answer, this is a new reality we need to accept.

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Connect with Harpreet by calling 905.790.0657 Or email [email protected] or visit us www.wadehrapc.ca



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