This past summer, the federal government has proposed a few changes to taxes that will affect incorporated small businesses. For the most part, I agree with the changes. It’s time for the more wealthy small business owners to pay more in taxes.
There is much in the media about how the changes will negatively affect small businesses in our communities. I would like to explain the changes being proposed and which small businesses will really be affected.
For most small incorporated businesses earning under $150,000, which is by far the majority in Canada, the changes will have little effect on the business owners.
It’s been reported that about 5% of Canada’s small incorporated businesses have had substantial tax savings from income splitting (they earn $200,000 to 500,000 per year). And many of these are professionals, not the traditional “small mom and pop business”. The annual cost to the federal government in taxes not collected from this loophole is about $280 million; the cost to provinces is about $110 million. I believe these tax dollars should come from these high income small businesses instead of low and middle class Canadians.
Those most likely to be affected by the proposed changes are the “high income professionals”, such as doctors, dentists, chiropractors, lawyers, accountants, real estate agents and life insurance agents. These are the ones that have been encouraged by tax accountants to incorporate in the past 10+ years “in order to save tax dollars by sprinkling income”.
Sprinkling income means they can share the profit of the business with their spouse and adult children and reduce the overall tax bill (several people claiming a total of 300,000 of income pay a lot less taxes than one person claiming 300,000 of income).
More traditional small businesses (small farms, restaurants, and small retail businesses) are less likely to benefit from income splitting and won’t be affected (or minimally) by the proposed tax changes. And yet various interest groups in the media are crying out these are the ones that are going to be negatively affected.
First, full disclosure: my business is a small incorporated business. The definition of small business is net annual profit of under $500,000. Most businesses with income under $150,000 will not be affected. And that is the majority of small incorporated businesses in Canada.
I want to quickly explain how business and personal taxes work. Generally they are integrated. That means the taxes are generally the same regardless of how they are earned. A self-employed individual who earns 60,000 pays about the same amount of taxes as the corporation that pays about 12% tax on that 60,000 income, and then pays the business owner the difference and that individual pays tax on the $52,800. Generally, the total taxes paid are the same.
If the taxes are the same or integrated, why incorporate? Mostly to defer the personal taxes, much like an RRSP. Defer taking money out of the business; the personal income and related taxes won’t be paid until later when the income may be lower. I also decided to incorporate to reduce my contribution to Canada Pension Plan (but that is another conversation).
By incorporating my business, I am able to pay dividends (business profits) to myself and to my husband. (And adult children if we had any.) Again, full disclosure: I have taken advantage of this “tax loop hole” and have paid some of the profits from my business to my husband in the form of dividends. He does not contribute to the business in any meaningful way (he does not work in the business).
So in the future, instead of sharing profits with him, I will need to claim all dividends from the business on my own personal tax return. Not a huge concern. Yes more income taxes I will need to pay, but not a huge amount of additional taxes. And no reason to make any changes to my business or future plans.
These seem to be the comments in the media: “The sky is falling! Businesses will close! Professionals will leave Canada go to the USA!”
I disagree. Maybe it’s the tax accountants that are concerned they will have fewer clients if there is no overall tax savings to the high income professionals and they won’t incorporate any more.
A quick reminder of the last few Death Café’s for the year: Saturday October 14 (inviting baby boomers with elderly parents), Thursday, October 19, and Thursday November 23. Call to sign up!
Anni Markmann is a Personal Income Tax Professional and Certified Financial Planner; living, working, and volunteering in our community. Contact her at 204.422.6631 or 36 Dawson Road in Ste Anne (near Co-op) or Info@SteAnneTaxService.ca