After much fear and trepidation, the changes to private company taxation were much less punitive than expected in the latest Federal Budget. What Finance Minister Morneau had originally proposed to do back in July of 2017 was heavily watered down.
If you’re a professional with a corporation, or a small business owner, the budget made two changes that affect you. One change might reduce your access to the small-business tax rate, and the second involves a small change to the tax integration mechanism known as Refundable Dividend Tax on Hand. This second change is quite a bit more complex, and has a relatively smaller impact, so I’ll leave it to another video. So how have the Feds reduced access to the small business tax rate?
Let’s start with a little background. Until the 2018 Federal Budget, corporations paid 10% federal tax on the first $500,000 of active business income, and 15% on the excess. Quebec charges 8% on the first $500,000 of business income and 11.7% on the excess. So, the combined tax rates for Quebec-based corporations were therefore 18% and 26.7% respectively.
Now Quebec had already put measures in place to limit access to their small business tax rate. Essentially, you must have at least 3 full time employees in your Quebec based corporation, in order to gain access to the Quebec small business tax rate.
This effectively removed access to the low provincial rate for all incorporated professionals, like doctors and lawyers.
The Feds, on the other hand, hadn’t put any such measures in place, but have been increasingly concerned about the tax advantage that professionals were getting through their corporations. So here’s what they did: For every $1 of investment income over $50,000 that a corporation earns, the small business income tax threshold will be reduced by $5. If you do the math, you lose access to the small-business tax rate completely once your investment income reaches $150,000 in a given year.
So once the investment portfolio inside the company is over about $1 million, you’ll likely have more and more of the business income taxed at the higher rate. When you reach a portfolio of $3 million, you’ll likely lose access to the lower tax rate completely.
There is a bright side to all this; these changes will apply in 2019 so that gives us a little time to figure out how you’re affected and what you can do with your business to prepare for the changes.