As we approach the end of the year, it is time to consider some tax planning opportunities that may be available to you for 2020. The planning points outlined below are not intended to serve as specific advice; you should always consult your D&H advisor before implementing any of the suggestions contained in this newsletter.
OWNER-MANAGER REMUNERATION
The right mix of salaries and dividends to the owner-manager will ensure taxes are minimized while taking into consideration Registered Retirement Savings Plan entitlements, Canada Pension Plan contributions, the Tax on Split Income, and the BC Employer Health Tax. Income splitting may also be possible if a family member provides services for which the individual can be paid a reasonable salary; this works particularly well where the family member has little or no income.
LIFETIME CAPITAL GAINS EXEMPTION
The lifetime capital gains exemption limit increased to $883,384 (from $866,912 in 2019) effective for dispositions of ‘qualified small business corporation’ shares by individuals occurring in 2020. The lifetime capital gains exemption limit on qualified small business corporation shares is indexed to inflation for future tax years.
The lifetime capital gains exemption limit for “qualified farm and fishing property” is $1,000,000 for qualifying dispositions by individuals occurring in 2020.
PERSONAL INCOME TAX RATES
The combined federal and provincial top marginal tax rate has increased to 53.50% (from 49.80% in 2019), and the top marginal tax bracket now applies for income in excess of $ 220,000 (from $ 210,371 in 2019).
The maximum marginal tax rate for eligible dividends for 2020 is 36.54% (2019 – 31.44%).
The maximum marginal tax rate for regular dividends for 2020 is 48.89% (2019 – 44.64%).
PRINCIPAL RESIDENCE RULES
The principal residence exemption provides a reduction in the gain that would otherwise be realized on the disposition of a ‘housing unit’ (e.g. house, condo, townhouse, cottage, share of housing co-op, etc.) by an individual resident in Canada who ordinarily inhabited the property. In order for a property to qualify as a principal residence, the housing unit must be designated as the principal residence for each taxation year. However, only one property can be designated each year for a family unit (i.e. spouses and minor children).
The algebraic formula used to determine the amount by which the gain may be reduced allows for a “plus-one” rule, which provides an additional year that the property may be eligible to be designated as the individual’s principal residence. This rule is intended to allow an individual to designate a property in the year that the individual moves from an existing principal residence to a new principal residence.
The Income Tax Act (Canada) was amended in 2016 to reflect that the taxpayer must be a resident of Canada in the taxation year in which they acquired the property in order to claim the “plus-one” year rule in the formula. If the taxpayer was not a resident of Canada in the year of acquisition, they will not be eligible to claim the “plus-one” year.
The Canada Revenue Agency (“CRA”) has also modified their administrative policy for reporting dispositions of a principal residence. Effective for dispositions on or after January 1, 2016, individuals will now be required to report any disposition of a principal residence on Schedule 3, Capital Gains, of their T1 Income Tax and Benefit Return. The year of acquisition, proceeds of disposition, and description of the property will need to be reported. This change also applies to deemed dispositions of property, such as a deemed disposition on the change in use of the property.
Form T2091, Designation of a property as a principal residence by an individual (other than a personal trust), is also required to be filed for all dispositions of a principal residence.
The CRA will only allow the principal residence exemption on property disposed of in 2016 and later years if the sale and designation is reported in the return. Late filed designations may be accepted but are subject to a penalty equal to the lesser of (i) $8,000 and (ii) $100 for each month the designation is late. The designation is due with the return on April 30, 2021 for the 2020 taxation year.
TRUST INCOME ALLOCATIONS
Income not allocated from an inter-vivos trust to an income beneficiary of the trust is taxed at the highest marginal personal tax rate (53.50% for 2020 for B.C. resident trusts) in the trust. In order to allocate income from an inter-vivos trust to a beneficiary in 2020, the income must be paid or payable to the beneficiary on or before December 31st, 2020.
Care should be taken when allocating certain types of income, such as private company dividends, to beneficiaries as the “Tax on Split Income” (“TOSI”) may apply to tax such income at the highest marginal personal tax rate.
TAX ON SPLIT INCOME (“TOSI”)
Prior to 2018, the TOSI rules imposed taxes at the top marginal rates on certain types of income of a child under the age of 18, such as dividends from private corporations, or certain types of income earned through a trust or partnership.
Effective January 1, 2018, the TOSI rules were expanded to include most individuals. Individuals over the age of 17 will be subject to TOSI on certain types of income received that is not commensurate with a “reasonable” amount that would otherwise be received for their active involvement in the business, contribution of assets, or risks assumed in respect of the business. The types of income subject to TOSI have been expanded to include income from certain debt obligations, gains from certain dispositions of property (the income from which is split income), and compound income earned on property that was previously subject to TOSI.
If you have questions about the TOSI rules read to our comments in the “Income Sprinkling Measures” section of our 2018 Federal Budget Commentary for further information or contact your D&H advisor.
REVIEW YOUR WILL
Changes to the Income Tax Act (Canada) that came into effect in 2016 will tax certain trusts at the top marginal tax rate. If your will includes the creation of a trust, you should consider the tax impact and review your estate plan accordingly.
If you plan to make gifts to charity through your will or estate, you may be able to benefit from more flexibility in the use of your estate’s charitable donation tax credits by allocating the charitable donation credit between the terminal tax return for the year of death and the estate tax return after death to obtain a more favourable tax position. This can be done when the tax returns are prepared and does not necessarily require a change to your will.
LOW-INTEREST LOANS
The CRA’s prescribed rate of interest is currently 1% for the final quarter of 2020. This low interest rate provides tax planning opportunities for individuals to split income with family members using related party loans.
Related party loans that bear interest at a rate equal to the prescribed rate in effect as of the date of the loan can provide significant tax savings. A properly structured loan avoids the attribution rules which would otherwise apply to funds that are lent to your spouse or minor children, whether through a trust or otherwise, on an interest free basis. Annual interest payments made to you from the loaned funds will be taxed as income in your hands; however, any income generated by the recipient of the loan will be taxed as income in the hands of the recipient. Consequently, significant income can be shifted from your hands into the hands of a family member with a lower marginal tax rate.
Interest charged on related party loans outstanding in 2020 must be paid before January 30, 2021 in order to avoid the attribution rules.
Contact your D&H advisor if you feel that you may benefit from such an arrangement.
CAPITAL LOSSES
Capital losses may be used to offset capital gains realized during the year, reducing the income taxes that are payable for 2020. Therefore, it may make sense to sell investments that have dropped in value in order to realize a loss. To trigger capital losses before the end of the year, the transaction settlement date must be on or before December 31, 2020. The time it takes to settle a trade will vary depending on the nature of the security and the exchange on which it is listed. Check with your financial institution to determine the last date your trade can be initiated to ensure that it settles by December 31, 2020; the last trade date for most publicly traded stocks will be Tuesday, December 29, 2020.
Want to buy back the same investments? Wait until at least 30 days have elapsed after the settlement date – otherwise, your losses will be denied and added to the cost base of your re-purchased investments.
If you transfer investments with accrued losses from non-registered accounts to registered accounts (i.e. RRSP or TFSA) to realize the loss, as these losses are denied under the tax rules. If you want to realize the loss and keep the investment, it is best to sell the investment, contribute the cash to the RRSP or TFSA, and then buy back the investment after the 30 day period ends.
If your capital losses exceed your capital gains in 2020, the net capital losses may be carried back three years or carried forward indefinitely to offset taxable capital gains in other years.
