Just as your ambitions are uniquely your own, so too is your tax situation. No single tax strategy will fit all scenarios. Instead, your tax obligations may require a personalized guiding plan with annual tinkering and consultations with tax advisors as your wealth accumulates or your business evolves.
"Tax management can be important, particularly if you have worked hard to build up a business or a career. You want to be able to enjoy what you have earned and protect it," says Geoffrey Chen, a High Net Worth Planner with TD Wealth who works with wealthy families and business owners to help optimize their financial plans. He says tax planning is a subset of financial and business planning and not the other way around -"If you structure your life and corporation around tax issues, you may lose sight of your ultimate goals." he says.
The first area executives or business owners should look to maximize is their contributions to registered accounts, says Chen. That would include Registered Retirement Savings Plans (RRSPs), Registered Educational Savings Plans (RESPs) and Tax-Free Savings Accounts (TFSAs), assuming you qualify. These plans are the starting point since contributing mitigates tax exposure in various ways.
As well, Chen says most high net worth individuals should also consider utilizing RRSPs another way: Income splitting through spousal RRSPs or by splitting a pension, which can lower the taxable income (and therefore the tax exposure) of the higher earning spouse by transferring that income to the lower income earning spouse.
"Everyone should also be making contributions to their favorite registered charities which can provide you with tax credits," says Chen. But there may be other, more specialized tax strategies that high net worth Canadians can employ to preserve their wealth. "Once these primary tax moves are completed, individuals may still wish to manage the tax implications of their wealth."
We talked to Chen who offered the following tax strategies for individuals who may have more complex situations and significant wealth. Read on to see if these may apply to you.
Who might consider this? A sole proprietor or someone starting a new business.
Owning an incorporated business can allow you to keep funds within the company structure where there is preferential tax treatment. The most obvious example is that the tax rate for small businesses (9% to 13%) is considerably less than the personal tax rate for individuals (which may be closer to 50%). There may also be significant tax deferral opportunities and, depending on the nature of the business, a significant lifetime capital gains exemption available for the owners.
If you privately hold real estate situated in the U.S. in excess of US$60,000 and your worldwide assets exceed US$11.7million as of 2021, then you may be subject to U.S. estate tax. However, Chen says holding any U.S. real estate through the corporation can be an effective strategy to mitigate U.S. estate tax concerns.
"With limited liability, incorporating your business also helps prevent the owner from risking their private wealth if the business is sued or fails," Chen says.
Business owners and entrepreneurs should be aware of the legal and accounting charges involved with setting up a corporation: Shareholder agreements, articles of incorporation, annual financial statements and reports and filing tax returns are just some of the costs involved.
Who might consider this? High income family members with surplus funds.
Similar to income splitting, this strategy may lower the overall tax obligation for a family and may be suitable for higher income families with liquid assets. Briefly, it involves a higher income family member loaning a lower income member funds at the government prescribed rate of interest. The recipient can invest the money and pocket the capital gains after they have paid back interest on the loan. In this way, funds have shifted from an individual in a higher tax bracket to a lower tax bracket where the overall tax impact is less. The rate of the prescribed loan fluctuates with interest rates which is why this strategy makes most sense when the rate is low and the investment returns can justify the cost of the arrangement, says Chen. But unlike pension income splitting and spousal RRSPs, this strategy can not only include spouses as the recipients of the loans but also minor children.
Chen points out some other things to consider: For instance, the loan must be documented, and interest must be paid annually on or before January 30 each year or attribution rules kick in. The amount of money loaned should be sizable so that the investment gains offset any expenses involved in structuring the loan. And because this strategy involves investments in the market, it comes with a certain amount of risk and should be done with the assistance of a financial professional.
Who might consider this? Families who are sharing wealth and complex tax issues.
Chen says the tax benefits of a trust are the abilities to distribute wealth to family members and to lower the overall tax exposure of the family. A trust, which is regarded as a taxpayer for Canadian income tax purposes, is a legal relationship between the person who sets up the trust (the settler), the person who manages the assets in the trust (the trustee) and the individuals who benefit directly — the beneficiaries of the assets. It can be used to mitigate taxes around the transfer of property, estate planning or preserve assets for minors.
"The trustees have flexibility to make decisions based on business conditions, impending tax events or the needs of the family," says Chen. "They have the discretion on when and how to make payouts to family members in a tax-efficient manner. Some years it may not be appropriate to make large payments at all."
Chen says family trusts can offer other benefits: A trust can protect family wealth from spousal or creditor claims and minimize probate fees. One thing to keep in mind is that every 21 years from the date of the creation of the trust, it is deemed to have disposed of its assets at fair market value: Further tax planning for the trustee may be necessary as that date approaches.
Who might consider this? Anyone who wants to make a sizable contribution or become more involved with their favourite charity.
The tax benefits of eligible charitable donations are available to all Canadians and you may earn tax credits which can lower the amount of tax you owe. Donations can be claimed for the previous five years if they haven't been claimed previously.
There may be another option for high-net-worth individuals who may want to consider giving more to their favorite charity and earning greater benefits. Through a donor advised fund, a benefactor can set up their own account with a minimum of $10,000 with an established foundation and will receive the donation tax receipt up-front. The fund can also provide flexibility if you are initially unsure which charity to donate to as there is no obligation to give immediately to a specific charity. In the meantime, you can continue to contribute to your fund and your money can continue to grow.
As well as a tax credit, donating investments directly can potentially eliminate the capital gains tax on eligible securities. Eligible investments include investments trading on designated stock exchanges, segregated funds, mutual funds, and government bonds. Calculating the tax benefits is complex, says Chen, and depending on your situation, donating the investments, and receiving a tax credit may be more beneficial than selling the investments and facing capital gains.
Who might consider this? Executives with high incomes and small business owners.
High income earners may find at some point in their career that RRSPs may leave too much wealth exposed to tax. An alternative solution, says Chen, is an Individual Pension Plan (IPP), a registered and defined benefit pension plan that a company can structure for their executives. A small business owner may also benefit from an IPP although to qualify they must pay themselves a salary.
An IPP can create more contribution room over and above RRSPs, and contribution room can significantly rise from there until age 65, says Chen, adding "the plans are based on the age and years of service of the recipient and usually become advantageous when the subscribers are in their middle 40s," says Chen.
Whichever tax measure you embark on, Chen recommends not going it alone and getting the best advice available before you make a move. That's because business environments change, families grow, income sources evolve, and often unexpected problems occur. A plan that looks correct from a business point of view may not be what your personal situation needs.
"There are expenses involved with meeting experts in taxation, accountancy and finance. Working out a dedicated plan for your situation can be time-consuming," Chen says. "But you'll get the best result and have a much better outlook on your whole situation and not just your taxes."