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July 23, 2017 | The Bite

A best-selling Canadian author of 14 books on economic trends, real estate, the financial crisis, personal finance strategies, taxation and politics. Nationally-known speaker and lecturer on macroeconomics, the housing market and investment techniques. He is a licensed Investment Advisor with a fee-based, no-commission Toronto-based practice serving clients across Canada.

And what’s the prime minister been up to lately, I hear you cry? Besides posing in his pink shirt between two cross-dressers in Halifaxon the weekend? Let’s just hope they’re not incorporated, high-income IT guys when they unstaple their bosoms, or they might feel differently about Mr. Selfie.

Like Alberta Guy, a blog dog now in the crosshairs of the latest federal eat-the-rich campaign. You recall that days ago Ottawa declared war on self-employed professionals, with wealthy doctors and fancy lawyers getting no sympathy from the barking packs of jealous Millennials. But that’s just part of it. By attacking private corps, our government has confounded a mess of ordinary, non-rich people.

“You have been writing lately about incorporated companies and the upcoming changes expected from CRA,” says AG – who spend several of the past few years unemployed. “I am one of those who have essentially been forced to incorporate to continue working as a contractor in my chosen field: IT and Telecommunications.

“My corporation has been paying out dividends to me and my partner enough each year to fund our lifestyle.  The remaining income has been retained and invested inside the corporation as this represents the bulk of our retirement fund.

“I am at a loss now as to what to do…

  • do i pull everything out this year with large dividend payouts and then look for other ways to invest outside of the corporation?
  • do i start paying salaries and be saddled with monthly EI, CPP, TAX and annual payroll and other mandatory reporting?
  • do i need to make changes to my investment mix within the corporation?
  • do i stay the course and hope that whatever measures are put in place by T2 will be reversed when the newly minted Harper with a smile takes the reigns back in 2019?

“Your sage and thoughtful advice is always welcome and appreciated (there got the mandatory suck up in at the end).”

As Alberta Guy knows, being an IT dude working on contract (because no oil & gas company wants actual employees any more) is solitary. No pension plan. No matched RRSP contributions. No profit-sharing. No benefits. No paid vacations. No company-subsidized life insurance, mat leave top-up or sick leave. All you get is a cheque each month made out to the incorporated entity the employer forced you to create. And now you have to pay your accountant three grand a year to file taxes that are incomprehensible to the layman. Plus, when the contract ends there’s no severance pay, no retirement package and zero recourse if you were diddled.

In return for this crap, you can income-split with your spouse if she/he has been cut in as a shareholder, and also invest any retirement money inside the corporation where it can grow in a less-taxed fashion than within a non-registered personal account. Until now. Until T2.

The feds have launched a consultation process on wiping away such benefits – but it’s consulting in name only. The legislation has been drafted, will be introduced into the Commons this fall or in the March budget, and passed. This is a certainty because everybody hates rich people (especially physicians, lawyers and financial advisors) and believes Canadians should be taxed the same as the typical MA in sociology who works at Starbucks.

What Alberta Guy’s been doing is 100% legal. He pays tax on the cash flow he draws and his spouse is taxed on her dividend income – paid out after the corporation hands over its own taxes. Yes, together they’re in a lower personal tax bracket than if he took all the money in his name alone. But when you add in the corp’s taxes, it evens out. As for the retained earnings, they grow at a lower rate inside the company, but will be taxed as personal income in retirement, when drawn. As with an RRSP, hopefully at a reduced level.

Again, all legal. All reasonable. Less tax now is the trade-off for future income insecurity. In a world where the tax system is based on risk and reward, not envy and spite, it makes sense. But that’s no longer our world. Not in T2’s Canada.

So Alberta Guy, here’s the plan. First, do nothing fast. The law is as yet unknown, could change and will not be retroactive. It is always best to see the exact changes to know exactly how to respond.

Second, having said that, income-splitting is doomed. The CRA will have a ‘negative test’ in which any employee/shareholder/officer/director related to the principal must prove compensation has been reasonably earned, whether as salary, dividend or distribution. This may be a messy and arbitrary process and the ‘reasonableness’ test is opaque at the moment. People with corps should be ready in 2018 for CRA’s default position to be the taxation all distributions at the top marginal rate unless the recipient can prove bone fide work paid at a market rate. So. Give your spouse a title and a valid job.

Third, even more vagueness surrounds the idea of taxing retained earnings invested within a CCPC. The government says returns will be ‘harmonized’ with income flowing from personal investment accounts, suggesting the default position will be to tax all corporate investment accounts at the marginal rate of the beneficial owner. Sucks.

So, hoarding retained earnings within companies as retirement funds is now a taxing strategy with no perceptible benefit. Strongly consider drawing enough salary, starting in 2018, to maximize RRSP room, taking advantage of that room, and receiving the remainder of after-tax corporate earnings as dividends. The days of using a corporation to shelter investment gains and have them taxed at the small business rate are soon to be over.

Unlike people with pensions, self-employed IT guys who retire with fat RRSPs can control their own after-work incomes, hopefully living for years on their fully-invested TFSAs so CPP and OAS payments are not clawed back. When interest rates rise you can also consider melting-down RRSPs with an investment loan, and getting money out tax-free.

Be creative. Or, if really desperate, get elected.

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July 23rd, 2017

Posted In: The Greater Fool

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