“Make hay while the sun shines” goes the old farming adage; the message being that one needs to cut and preserve hay before winter. Following the Federal Budget proposal on changes to the Capital Gains Inclusion (“CGI”) rates, a sudden tax winter now seems set to appear on June 25, 2024.
Since the budget, most accountants and financial planners we know have been inundated with queries and analyses around how to plan ahead for the proposed CGI changes. Investors want to know how these changes impact their situation now and in the future. Unfortunately, there are no easy answers or universal rules of thumb to work from. Every investor’s situation will be at least a little different depending on qualities such as: age, family circumstances, unrealized capital gains/losses, current and future needs for income, marginal tax rates, and so on.
With that said, as we dig through the myriad of unique circumstances, there are instances where proactive remuneration planning seem to present opportunities. Said plainly: by strategically adjusting compensation before June 25, we might make some hay before winter.
Case Study
Below is a case study representing a hypothetical incorporated physician. (We’ll call them Dr. Farmer so as to further torture the metaphor… for the amusement of all the dads reading this.) Dr. Farmer is 62 years old and intends to retire at age 65, at which point they will start drawing income from their corporation in conjunction with other investment accounts. Dr. Farmer draws $300,000 net of tax as income each year to cover living expenses.
Scenario 1 represents how Dr. Farmer would normally be compensated in 2024. This takes into account the total net-of-tax value of all corporate investments and income for the year.
*2023 Tax Rates Federal + Province of British Columbia[i]
The Original Plan (Scenario 1)
Dr. Farmer’s original plan was to start drawing a retirement income in 3 years and have the investment capital within the corporation to accumulate and grow. However, under the proposed capital gains rules, this exposes them to a 66.67% inclusion rate. Under this plan, at the end of the year and counting credits (CDA, RDTOH, etc.), Dr. Farmer has control over $1,627,613 in assets.
Making Hay (Scenario 2)
What if Dr. Farmer were to crystalize the unrealized gains in the corporation to benefit from the 50% CGI rate? If this were done, then a change to compensation could be made. Dr. Farmer could reduce the taxable income coming from the corporation, while still leaving a net $300,000 of income for the year. Doing this could potentially allow Dr. Farmer to effectively average down their marginal tax rate over multiple years. It’s also possible that this could leave more money in Dr. Farmer’s hands. Scenario 2 below illustrates this concept in action.
*2023 Tax Rates Federal + Province of British Columbia
Notice that Scenario 2 leaves just shy of $60,000 more for Dr. Farmer than in Scenario 1. This is achieved by replacing salary income from Dr. Farmer’s professional income with only income from tax-efficient dividends that are created if Dr. Farmer triggers a sale of assets at the 50% CGI Rate.
Why this might work:
- Dr. Farmer is retiring in 3 years, so this is the breakeven period for comparing the taxes paid now at 50% CGI and deferred investment growth if left as is but paying a 66.67% CGI in the future. In most analyses we’ve done, it appears that a holding period of 7 years is necessary to breakeven, assuming a rate of return of 7%.
- Current tax rates are a known quantity but future tax rates are unknown. In 2014 the top marginal tax rate in BC was 45.80% whereas now it is 53.50%[ii]. If the future followed the past and saw further tax increases, then the benefit of realizing tax now at lower rates would be further compounded.
Potential Notes of Caution:
- This strategy is a one-time option only, predicated on realizing the current capital gains inclusion rate and avoiding a higher one in the future.
- Scenario 2 has Dr. Farmer not paying into CPP for the year, given that they only receive non-salary income. While this saves $7,509 in costs, it could also potentially reduce Dr. Farmer’s CPP benefits in retirement if not within one of the eight potential CPP “drop-out” years.
- As of this article’s publication, it’s already nearing June. If Dr. Farmer was planning to pay a salary for 2024, it’s likely that already started, in which case the real scenario wouldn’t be quite as cleanly cut as laid out above. With that said, if we revised the numbers such that there was partial salary and partial dividends, the math doesn’t change too much and still seems to strongly favour realizing capital gains.
- This is sophisticated tax planning and requires the consultation of a tax professional to review all potential considerations.
The Bottom Line:
For those working professionals with moderate to large unrealized gains in their corporations, there may be meaningful potential tax savings to be found in reviewing their remuneration strategy for 2024 and beyond. Dr. Farmer is one such example.
While winter is fast approaching (June 25th), there’s still plenty of sunshine to potentially find savings if one applies prudent financial planning.
[i] Canadian federal tax bracket Canadian federal tax rate
$53,359 or less 15.00%
$53,359 - $106,717 20.50%
$106,717 - $165,430 26.00%
$165,430 - $235,675 29.00%
More than $235,675 33.00%
British Columbia tax bracket British Columbia tax rate
Up to $45,654 5.06%
$45,654 to $91,310 7.70%
$91,310 to $104,835 10.50%
$104,835 to $127,299 12.29%
$127,299 to $172,602 14.70%
$172,602 to $240,716 16.80%
Over $240,716 20.50%
[ii] https://www.taxtips.ca/priortaxrates/tax-rates-2013-2014/bc.htm and https://assets.ey.com/content/dam/ey-sites/ey-com/en_ca/topics/tax/tax-calculators/2023/ey-tax-rates-british-columbia-2023-06-01-v1.pdf
