June 20, 2012 saw the Ontario Liberal government legislate an additional 2% "wealth tax" on individuals and their taxable income in excess of $500,000. The additional tax will be phased in over 2012 and 2013 and the combined federal and Ontario top marginal rate of income tax on income over the new threshold will rise to 47.97% in 2012 and 49.53% in 2013. The current top rate is 46.41%. The Ontario government anticipates that the additional tax will generate approximately $470 million in revenues each year to be applied against the province’s current $15 billion deficit. The ‘wealth tax’ is expected to be eliminated when the provincial budget is balanced, which is projected to occur in 2017/2018.
As with any new income tax proposals, individuals should consider the impact on their own circumstances and evaluate their tax planning options as applicable.
Income Splitting with a Trust
Simple income splitting strategies can help you both avoid the ‘wealth tax’ in the short term, but may also provide long term benefits by taxing income in the hands of a family member who may be in a lower tax bracket. Establishing a family trust to transfer investment income to lower income family members is a commonly used alternative to split income with children, grandchildren or nieces and nephews. In Ontario, an individual with no other sources of income may earn approximately $10,500 of interest, $21,000 of capital gains, or $50,000 of eligible dividends each year tax free. It is important to consult a professional advisor with respect to setting up any family income splitting structure as the ‘attribution’ and/or ‘kiddie tax’ rules in the Income Tax Act (‘Act’) may nullify any tax benefit sought.
Spousal Loan
Another alternative to reduce your income that may attract the ‘wealth tax’ is to shift investment income to a low-income spouse through a spousal loan. This strategy involves setting up a formal loan arrangement at the Canada Revenue Agency’s prescribed rates. The loaned funds are then used by a lower income spouse to generate investment income on which they will pay tax at their lower rate. The higher income spouse will have to include the loan interest as income, however with the current prescribed rates at a historical low of 1%; the tax savings assuming positive investment returns should far outweigh the income inclusion. As with setting up a trust, it is important to consult a professional advisor to ensure that the ‘attribution’ rules don’t apply to any income earned on the loaned funds.
RRSP Contributions
Always an attractive alternative for reducing taxable income, registered retirement savings plan (‘RRSP’) contributions are among the easiest methods available to decrease your tax liability, providing that you or your spouse have the contribution room available. Funds invested in an RRSP not only provide immediate benefits by way of tax deductions but can continue to grow on a tax deferred basis. The investment income and capital gains generated in an RRSP will not be subject to tax until they are withdrawn from the plan.
Leave Funds in your Corporation
If you are a small business owner or an incorporated professional, you may want to consider leaving funds inside your corporation to be taxed to the extent you do not require them for personal needs. This approach can result in significant tax deferrals particularly where the corporation is eligible for the ‘small business deduction’ as defined in the Act. The first $500,000 of ‘active business income’ earned in Canada by a corporation eligible for the ‘small business deduction’ would be subject to combined federal and Ontario corporate taxes of approximately 15.5%. Even if the income is not eligible for the small business deduction but is otherwise considered active, a deferral opportunity still exists.
Investment Corporation
Another option if you do not require all of your investment income for your living expenses is to earn all or a portion of the investment income in a corporation. Typically, investment or holding corporations have not been an attractive option of late due to the higher corporate tax rates on investment income and the way in which the Act applies the tax. Yet now in comparing an Ontario investment corporation’s rate of tax of approximately 46.17% to the new ‘wealth tax’ rate of 49.53%, there is clearly a deferral opportunity.
Tax planning options such as those listed above and others can assist in reducing the impact of the ‘wealth tax’ on your personal tax liability both now and into the future. Whether or not you are affected by the ‘wealth tax’, it is important to recognize that tax planning is an ongoing process that needs to be regularly revisited to ensure no opportunities are missed.
Stephen Rupnarain, CA is a Tax Manager in the Toronto office at Collins Barrow.
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