Understanding the KiddieTax, Part 2

Another common plan prior to January 1^st, 2000 was to have a partnership whereby the child (or a trust of which the child was a beneficiary) would be a partner and have the partnership receive income from a related entity.  For example, the partnership could provide consulting services to a corporation owned by the parents.  The income received by the partnership could then be allocated to the partners, including the minor child, thus providing for simple yet effective income splitting.

Now both of these income splitting plans are subject to the “Kiddie Tax” to the extent that the income is received by a minor child.  As with most tax rules, many people do not know or understand these rules so it is best to educate yourself (such as you are in reading this blog) and plan with professionals, such us Kustom Design.

One of the typical types of income that is not split income and therefore not subject to the “kiddie tax” is capital gains.  Many plans were set up that involved related corporations that were structured to realize capital gains income.  These plans mainly involved having shares of the corporation being sold to a related corporation and resulting in a capital gain that is taxable in the child’s hands.  Prior to the 2011 Federal Budget, such a plan was often used to the extent that the accountant and/or tax lawyer and their client believed that the general anti-avoidance rule (“GAAR”) would not apply.  The Canada Revenue Agency(CRA), however, was not amused and would often times apply the GAAR to such a plan (with many cases still in the system).  New legislation was then introduced through the 2011 Federal Budget.

We’ll continue our discussion on this new legislation as well as how the Kiddie Tax applies to partnerships and trusts next week.  

Maximizing the use of your corporation Part 4

Maximizing the use of your corporation isn’t all about tax savings.  There are many other things to look at in your corporation such as building a good team and using leverage.  Looking at leverage, businesses seem to have to biggest option of creating sweat equity and you can leverage relationships as well as assets and even credit of the company.  Businesses can build their own credit rating and use assets, including accounts receivable, to leverage for financing.

One last thing that we will look at in this blog on maximizing your corporation is the Capital Gains Exemption.  Every Canadian taxpayer has a $750,000 lifetime Capital Gains Exemption.  This exemption is on qualified small business shares, as well as qualified farming and fishing property.  Here we will just talk about the qualified small business shares which are the shares of your corporation.  So in essence if you sell the shares of your corporation you, and each other shareholder, can make up to $750,000 in capital gains on the sale tax free!  If you don’t use this exemption before you pass away it is gone forever!  So what is it that makes the shares qualified?  Here are the factors:

1.      Must be a CCPC (Canadian Controlled Private Corporation)

2.      The Corporation’s assets must be used at least 90% for Active Income. 

3.      At least 50% of the Corporation’s Assets must have been used to carry on active business in CANADA.

4.      The shares must have been owned by you or a relative for a 24-month period prior to the sale.

5.      The shares can’t be acquired as payment for other shares, stock dividends, or the disposition of a property.

In the case of a trust each of the beneficiaries have the $750,000 Capital Gains Exemption as well as the trust has $750,000 of it’s own Capital Gains exemption on the sale of small business shares.  So it is very beneficial to have the a trust own the shares of the corporation(s).  This leads us into the final part of our series on corporations “Selling, closing, or passing on your corporation”  See you next blog!

Maximizing the use of your corporation Part 1

There are many factors to discuss in the topic of “Maximizing the use of your corporation”.  Educational articles should never replace good planning!  Knowledge is empowering but Wisdom to apply the knowledge is key!  Always combine planning with education.  Our goal at Kustom Design is to give you the best of both of these in the areas of tax, accounting and finance! 

One area to look at in maximizing the use of your corporation is the Small Business Deduction.  The Small Business Deduction is how a corporation typically pays much lower tax than individuals.  However, there is a limit (Small Business Deduction Limit).  Currently the Small Business Deduction is claimable by most Corporations in Canada and has a limit of up to $500,000 net income.  In laymen’s terms you can earn up to $500,000 Net Active Business Income in a corporation before you pay large tax rates.  Currently in Alberta you only pay 14% total Corporate Tax (Federal & Provincial) on net income up to $500,000 in your corporation.  Once you make over $500,000 net in an Alberta corporation you could be looking at your tax rate going from 14% to upwards of 39%.  So our goal is of course to pay the lowest tax for as long as possible.  We have many options, which could include:

1.      Structuring multiple corporations (non related) to split profits

2.      Using trusts in your structure

3.      Paying bonuses and other forms of remuneration to owners, employees etc.

There are always ways to save tax as you will see with Kustom Design!

In talking about the Small Business Deduction we also discussed net active business income.  Gross income is the full amount of income you take in to your business and net income is after all of your expenses, leaving the net income or net profit/loss.  In the case of the Small Business Deduction we are talking about net active income.  So now that we understand the word net, we must also understand active income.  The 2 main income categories are active and passive income.  Active income typically means you or someone else has to work for the money.  Passive income typically means that you are making money whether you work or not. Passive income is great and residual passive income is the best!  In the case of the Small Business Deduction we are talking about active income.  So that deduction will not apply to passive income, such as investment income, Capital Gains and rental income.  

Canadians Investing in the US

Many people decide to invest in the U.S. but don’t know the rules.  There are 2 ways that people invest in the U.S., directly and indirectly.  Investing directly means that you invest personally, or through an entity, in the U.S.  Investing indirectly is when you invest through a broker and they put you into U.S. investments, partially or wholly.  Investing directly in the U.S. allows you to crystallize the type of passive income you will receive.  As discussed in other blogs, different types of income are taxed differently.  Of course investing in the U.S. brings more complication so you should know at least the basics before investing in the U.S.  Capital Gains is typically the best type of passive income you can receive from U.S. investments as, just like in Canada, only 50% of the gain is taxable.  Unlike Canadian dividends, dividends from a U.S. corporation or trust are considered non qualifying dividends.  This means there is no tax credit associated with the dividend, so you pay the full tax on the dividend income, just as you do on interest income.  Sometimes dividends earned from the U.S. show up on a Tslip as other income.  When reporting U.S. investment income on your Canadian return you must exchange the U.S. income to Canadian dollar income.  The acceptable exchange rates include the average for the calendar year the income was earned, or the exchange rate on the day the income was received.  The best place to get the acceptable exchange rates is from the Bank of Canada website.  There is typically no need to file a U.S. tax return or pay U.S. taxes on your U.S. investments when you are not a U.S. citizen (living in Canada), however there are exceptions.  One such exception is the sale of Real Estate, where there will be an amount held back for U.S. income tax.  In this case you need to file a U.S. tax return to ensure you don’t get double taxed in both Canada the U.S.  In my next blog we will discuss some of the basic ins and outs of purchasing and selling real estate in the U.S.

Donating Stocks to avoid capital gains while getting a donation credit

Giving should always be part of your financial and tax plan.  When you give you receive, and although that should never be the motivation of giving, it is an important fact.  Many people have realized that donating to charities can save significant tax savings.  Donating can save taxpayers hundreds of thousands of dollars in taxes by giving strategically. 

Giving stocks is not new, however over the last few years the rules are different in that their used to be a capital gain triggered when you donated a stock.  Now when you donate qualified stocks to a registered Canadian charity there is no capital gain triggered, yet you still receive the full donation credit for the value of the stock.

This can be particularly beneficial in the case of Flow Through and Super Flow Through Shares that have been acquired, considering there was already tax benefits for acquiring the Flow Throughs in the first place!  Although it is typically better to donate personally, many would ask what to do if they have stocks owned by a corporation.  In that case you could still donate the stock and receive a tax deduction for your corporation (instead of a tax credit) and the corporation would not trigger a capital gain.  This would also free up room in your capital dividend account to issue yourself or other shareholders tax free dividends.

Getting Assets into and Funding your Family Trust - Part 2

As mentioned at the end of my last blog, there are 4 main ways that you can get assets or funds into a trust and each of them are dealt with differently for tax purposes:

1. Lend

2. Gift/Transfer

3. Sell/Acquire

4. Income from Business and/or investments

Let’s start with lending to a trust. You can lend money or assets to a trust, by simply taking back a Promissory Note. This means that the Trust is taking a loan from you and is going to pay interest no less than once a year and intents to one day pay back the principal. When lending to a trust the current prescribed interest rate must be used as the minimum interest rate for the loan. You can go higher if there is a purpose for doing so. Currently the prescribed interest rate is quite low at 1% (as of the date of this blog) and has been that low for over a year now. This is extremely beneficial for loaning to a trust or Corporation as well as for spousal loans. If you have any such loans that are still at a higher interest rate, now would be the time to reissue the loan at the lower interest rate. Interest on loans must be paid within 30 days after the trust’s year end. A Family Trust has a year end date of December 31^st, so the interest must be paid by January 31^st of the following year.

Let’s now talk about gifting to a trust. Gifting to a trust is not used in many circumstances as there are many issues around gifting to a trust. As discussed in the last blog, when assets are put into a trust they must be put in at Fair Market Value. This is of course true if a gift is coming to the trust, meaning that the person gifting the assets may have a capital gain on the “deemed disposition” of the asset. If there is no gain on the asset then this would be irrelevant, however it is something that must be considered before the gifting happens. We also must look at attribution when an asset is being gifted to a trust. For example if someone gifted the trust some stocks, then the income from the stocks may be attributable back to the person who gifted the stocks. There are many considerations when looking at gifting to a trust, and in fact it may not be the best option to get assets into a trust. Typically the settlor and trustees would not want to make gifts after the set up of the trust.

Again, it is best to consult with a professional before making any movement of assets and/or funds into and out of a trust. Kustom Design is here to help you. In my next blog we will discuss the other 2 ways to get assets and funds into a trust.

Benefits of a Family Trust - Part 2

Income splitting is another major benefit of having a family trust. When tax planning you want to have the lowest household income, and income splitting is a very important tool to minimize your taxes. Income splitting allows lower income earners to receive additional income at a lower marginal tax rate. In a trust, dividend income can be split between beneficiaries. So if dividends come into the trust, they can be distributed between all beneficiaries. However, with respect to dividends from corporations that are not listed on a prescribed stock exchange, they must be allocated to beneficiaries who have reached the age of majority, which is 18 in Alberta. Interest income that comes into the trust may also be split amongst beneficiaries as well.

The other type of passive income that a trust may receive is Capital Gains, and typically they cannot split between spouses and family members after the fact. To split Capital Gains without a trust the individuals that want to split the gain in the end have to jointly purchase the asset. This can be an issue in tax planning as you don’t always know what income brackets the joint individuals will be in when they sell the asset, or one of the individuals may not have the funds to acquire the asset. However, with a trust you can split the Capital Gain amongst the beneficiaries after the sale of an asset. This is key in tax planning as Capital Gains can be large and are typically claimed by individuals who are in higher income brackets as they originally purchased the asset.

Not only can you split the Capital Gain among the beneficiaries of a trust, but if the Capital Gain is eligible for the Capital Gains Exemption (currently $750,000 lifetime exemption) you may also utilize any or all of the trusts’ beneficiaries Capital Gains Exemption. On top of this, the trust also has its own Capital Gains Exemption of $750,000. So if you had sold the qualifying shares of your Corporation, qualifying farming property, or qualifying fishing property then you could receive Millions of dollars in tax free Capital Gains!

So as you can see tax planning with a family trust gives you a major advantage in income splitting. Remember that tax planning should be done throughout the year so please do come in to plan with us at Kustom Design. Our goal is to save you more than you pay us in accounting and/or tax preparation fees, and we typically save you a lot more! Watch for my next blogs as we continue to discuss the benefits of a family trust.