Higher personal income levels are taxed at higher personal rates, while lower levels are taxed at lower rates. Therefore, individuals may want to, where possible, adjust income out of high-income years and into low-income years. This is particularly useful if the taxpayer is expecting a large fluctuation in income due to, for example, an impending:
- maternity/paternity leave;
- large bonus/dividend; or
- sale of a company or investment assets.
In addition to increases in marginal tax rates, individuals should consider other costs of additional income. For example, an individual with a child may receive reduced Canada child benefit (CCB) payments. Likewise, excessive personal income may reduce the receipt of OAS, GIS, GST/HST credit and other provincial/ territorial programs.
There are various ways to smooth income over several years to ensure an individual is maximizing access to the lowest marginal tax rates.
- Taking more or less earnings out of the corporation (in respect of owner-managed companies).
- Realizing capital gains/losses by selling investments.
- Deciding whether to claim RRSP contributions made in the current year or carry forward the contributions.
- Withdrawing funds from an RRSP to increase income. However, care should be given to the loss in the RRSP room based on the withdrawal.
- Deciding whether or not to claim CCA on assets used to earn rental/business income.
Dividends paid to shareholders of a corporation that do not “meaningfully contribute” to the business may result in higher taxes due to the “tax on split income” rules.
Year-end planning considerations not specifically related to changes in income levels and marginal tax rates include:
1) NEW! The alternative minimum tax (AMT) regime is proposed to change for 2024. Individuals may find themselves subject to a larger AMT liability in 2024 and onwards if they have high earnings (above approximately $173,000) and experience certain events with tax-advantaged benefits, such as large capital gains (including the use of the lifetime capital gains deduction) and significant charitable donations. In some cases, triggering transactions in 2023 may be advantageous.
2) Corporate earnings in excess of personal requirements could be left in the company to obtain a tax deferral (the personal tax is paid when cash is withdrawn from the company). The effect on the qualified small business corporation status should be reviewed before selling the shares where large amounts of capital have accumulated. In addition, changes that may limit access to the small business deduction where significant corporate passive investment income is earned should be reviewed.
3) If dividends are paid out of a struggling business with a tax debt that cannot be paid, the recipient could be held liable for a portion of the corporation’s tax debt, not exceeding the value of the dividend.
4) Individuals who wish to contribute to the CPP or an RRSP may require a salary to generate earned income. RRSP contribution room increases by 18% of the previous year’s earned income up to a yearly prescribed maximum ($30,780 for 2023; $31,560 for 2024).
5) Consider paying taxable dividends to obtain a refund from the refundable dividend tax on hand account in the corporation. The refund amount may be restricted if eligible dividends are paid. Eligible dividends are subject to lower personal tax rates.
6) It is costlier, from a tax perspective, to earn income in a corporation from sales to other private corporations in which the seller or a non-arm’s length person has an interest. As such, consideration may be given to paying a bonus to the shareholder and specifically tracking it to those higher-taxed sales. Such a payment may reduce the total income taxed at higher rates.
7) Access to the corporate federal small business deduction is reduced where more than $50,000 of passive income is earned in the corporation. Consider whether it is appropriate to remove passive income-generating assets from the corporation and whether a shift in the types of passive assets held is appropriate. In some provinces, it may actually be beneficial to have access to the federal small business deduction reduced. As many variables affect these decisions, consultation with a professional advisor is suggested.
8) If you provide services to a small number of clients through a corporation (that would otherwise be considered your employer), CRA could classify the business as a personal services business. There are significant negative tax implications of such a classification. Consider discussing risk and exposure minimization strategies (such as paying a salary to the incorporated worker) with a professional advisor in such scenarios.
9) NEW! Effective January 1, 2023, all gains arising from the disposition of residential property (including assignment sales) owned for less than 365 days are deemed to be business income (taxed at the full rate and not eligible for the principal residence deduction) unless a particular exception is met. Consider holding such properties for more than 365 days to avoid the application of these rules. Gains on such dispositions later than 365 days may still be classified as business income under the traditional rules, depending on the nature of the transaction.