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 Geoff 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.”
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 can help mitigate tax exposure in various ways.
As well, Chen says most high net worth individuals should also consider utilizing RRSPs another way: income splitting through the use of spousal RRSPs 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 consider making contributions to their favorite registered charities which can provide you with tax credits,” says Chen. But there may be other, more specialized strategies that high-net-worth Canadians can employ to preserve their wealth. “Once these primary tax moves are implemented, 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.
Incorporation
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 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.
Prescribed rate loans
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, which is why this strategy may make most sense when the rate is low and the investment returns can help justify the cost of the arrangement, says Chen. But unlike pension income splitting and spousal RRSPs, this strategy can not only included 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.