Financial Planning Strategies

Jamie GolombekManaging Director, Tax and Estate Planning

Ontario Psychological Association

February 19, 2015

Presented by:

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Agenda

Professional corporation

Income splitting

Postsecondary education savings

RRSP, TFSA or Mortgage?

Estate planning

Use of professional corporation

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Use separate business and personal financial accounts:– Bank accounts– Credit cards– Investment accounts– Lines of credit and loans

Keeping track of expenses

Good records separate business and personal expenses

Keep good records (logs, receipts), especially for expenses that have both business and personal elements such as:– Home office expenses– Vehicles used for both business and personal trips– Computers, phones with both business and personal use

Non-deductible personal expenses generally include:– Travel to/from work– Clothing for work– Personal meals– Home expenses that do not relate to a home office

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Personal expenses – An extreme case

Taxpayer admitted: “there could be or ‘may be’ personal expenses amongst the amounts in dispute”

670 receipts placed “into a drawer without organizing them”

– spa treatments, vitamins, gym memberships

– vacuum cleaner, driveway sealing– household items (including a Magic

Bullet blender that was returned)– women’s clothing– grocery items and alcohol

consumed by taxpayer / family / friends

– movie ticket stubs given as “entertainment for his clients”

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Common structures: Sole proprietor / Professional Corporation

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Sole Proprietor

Business Income

Business Income

Prof. Corporation

Dividend

Shareholder

Corporate tax

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Corporation

* Corporate tax rate is assumed to be 20%

Business income 1,800

Business expenses ( 800)

Net business income 1,000

Tax* ( 200)

After-tax 800

Tax payable$200

Tax on business income is paid by the corporation

ON 2015 – Advantage of low corporate tax rates

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Take advantage of “cheaper” corporate dollars to pay non-deductible expenses (e.g. life insurance premiums)

– Example – Annual life insurance premiums – $10,000 non-deductible– Paid personally – Earn $19,814 to net $10,000 (49.5% personal tax rate)– Paid corporately – Earn $11,834 to net $10,000 (15.5% corporate tax rate)– SAVINGS: $ 7,980 annually

ON 2015

15.5%

Co

rpo

rateON 2015

49.5% *Pers

on

al

* With taxable income exceeding $220,000

Withdrawing funds from a corporationOption 1 – Salary

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Salaries paid to employees are deductible in the corporation

Salaries received by employees are included in individual income

* Personal tax rate is assumed to be 43%

Business income 1,000

Salary (1,000)

Net business income 0

Shareholder

Corporation

Tax payable

$430

Salary income 1,000

Tax* ( 430)

After-tax 570

Salaries – RRSP contribution room + CPP

RRSP contribution room– 18% of prior year’s earned income– Maximum contribution room: $24,930– Maximum contributions can be made with 2014 salary of $138,500

CPP premiums on earnings to $53,600

– Max. employee premium: $2,480– Max. employer premium: $2,480– Total premium: $4,960

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Withdrawing funds from a corporationOption 2 – Dividends

After-tax income from the corporation is distributed to the shareholder as a dividend

Dividends received by shareholders are included in individual income

Tax payable

$230

Tax payable

$200

* Corporate tax rate is assumed to be 20%Personal tax rate on dividend is assumed to be 29%

Total tax payable

$430

Corporation

Net business income 1,000

Tax* ( 200)

After-tax income 800

Shareholder

Dividend 800

Tax* ( 230)

After-tax income 570

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Corporation

Dividends: Tax deferral

Dividends do not need to be paid in year business income is earned

By paying dividends in a later year, tax of $230 can be deferred by shareholder until year dividend is received

The $230 deferred amount can be reinvested in the corporation to earn additional income

Net business income 1,000

Tax* ( 200)

After-tax income 800

Shareholder

Tax payable

$230in 5 years

Dividend 800

Tax* ( 230)

After-tax income 570

* Corporate tax rate is assumed to be 20%Personal tax rate on dividend is assumed to be 29%

Dividendin 5 years

Tax payable

$200

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ON 2015 – Dividends: Tax savings Income Below Small Business Deduction Limit

With “perfect integration”, the amount of total tax for corporation + shareholder = tax for sole proprietor

In 2015, integration is nearly perfect in ON with shareholder income exceeding $220,000

After-tax amount is$1 lower withcorporation

0.1% tax savings

Corporation

ShareholderSole Proprietor

Net business income 1,000

Tax ( 155)

After-tax 845

Net business income 1,000

Tax* ( 495)

After-tax 505

Dividend income 845

Tax* (339)

After-tax 506

* With taxable income exceeding $220,000

$100,000

$75,000

$50,000

$25,000

$0

>Shareholder

$50,600Dividends

$84,500Corporation

After-taxdividend$50,600

Personal taxon dividend

$33,900

Corporate after-tax businessincome$84,500

Corporate tax$15,500

Personal taxon salary$49,500

After-taxSalary

$50,500

Employee$50,500

ON 2015 – $100,000 small business incomeearned in an Ontario professional corporation

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Plan before year end Dividends vs. bonus in ON in 2015

Reasons dividends may be preferable to salary/bonus:1. Tax deferral of 34% if small business income is not withdrawn from the

corporation in the year it is earned2. Payroll tax savings over $7,000 annually (CPP/EI) per employee

Income splitting with prescribed rate loans

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Income splitting - Attribution rules

Gifts/transfers of funds to spouse or partner – FULL attribution of income/gains back to transferor

Gifts/transfers of funds to children– Attribution of income (but not capital gains) back to transferor

Exceptions:– Pay FMV or prescribed rate loan

• Rate is 1% until June 30, 2015– Lowest possible!

Income splitting (cont.) Example of Spousal Loan at 1%

Income splitting opportunity: $20,000Tax Savings (ON): $20,000 X (49% - 20%) = $5,800/yr

Income $5,000

Jack

$500,000

Interest Expense 1%

Income $25,000Interest expense ( 5,000)Net income $20,000

Dianne

• Dianne loans Jack $500,000

• Investment earns 5% annually

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Income splitting – kids action plan

If kids < 18, set up family trust (through lawyer) Loan to trust at 1% (promissory note) Investment income earned in trust paid out to kids

(or used for their benefit) Kids pay zero (minimal) tax Tax-free (public company) dividends to kids

– about $50,000 (ON 2015)

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ON 2015 – Income splittingFunding children’s expenses

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Dividends (4%) $40,000Tax (33.8%*) ( 13,520)Net amount $26,480

$1,000,000 Capital

Can pay for $26,480 of

children’s expenses(e.g. private school)

* 2015 ON top marginal tax rate on eligible dividends is 33.8%.

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Dividends (4%) $40,000

Interest (1%) ( 10,000)

Net income $30,000

Interest (1%) $10,000

Distribution $30,000

$1 millionloan

@ 1% Trust

$1,000,000Investments

ON 2015 – Income splitting (cont.)Funding children’s expenses with a trust

U.S. citizens should consult with a U.S. tax professional prior to implementing loans involving family members.

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Dividends (4%) $40,000

Interest (1%) ( 10,000)

Net income $30,000

Interest (1%) $10,000

Tax (49.5%) ( 4,950)

After tax $ 5,050

Distribution* $30,000

After-tax funds 5,050

TOTAL $35,050

* Approximately $50,000 of eligible dividends can be earned tax-free by an individual who has no other income and claims the basic personal amount in ON in 2015.

Can pay for $35,050($8,570 more)

children’s expenses

$1 millionloan

@ 1% Trust

ON 2015 – Income splitting (cont.)Funding children’s expenses with a trust

$1,000,000Investments

Savings for Post Secondary Education

Registered Education Savings Plan (RESP)

Maximum lifetime contributions: $50,000

No deduction for contributions

Canada Education Savings Grant (CESG):

– 20% of first $2,500 of annual contributions ($500/year)– Can carry forward unused room

• Up to $1,000 CESG for a “catch-up” contribution

Earnings accrue on tax-deferred basis

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RESP – Typical strategyStart late; maximize CESG

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Pays for four years of school

at $12,766annually

RESP – Results with typical strategyStart late; maximize CESG

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CumulativeContributions

CumulativeCESG

CumulativeGrowth*

* 3% rate of return.

RESP – Better strategyStart early; maximize CESG

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RESP – Results with better strategyStart early; maximize CESG

Pays for 4 yrs of school at

$15,874annually

Yields $3,108 more than typical

strategy annually

($12,432 over four years)

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CumulativeContributions

CumulativeCESG

CumulativeGrowth*

* 3% rate of return.

RESP – Best strategyStart early; maximize contributions

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RESP – Results with best strategyStart early; maximize contributions

Pays for 4 yrs of school at

$22,099 annually

Yields $9,333 more than typical

strategy annually

($37,332 over four years)

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CumulativeContributions

CumulativeCESG

CumulativeGrowth*

* 3% rate of return.

RESP – Education Assistance Payments

Creditamountsexceedincome

No taxpayable

32* Assumes student attends school full-time for 8 months annually and tuition is $6,000/year.

The RRSP, the TFSA…or the mortgage?!

“As the TFSA matures over the next 20 years, it is estimated that, in combination with existing registered plans, it will permit over 90 per cent of Canadians to hold all their financial assets in tax-efficient savings vehicles.”

- The Budget Plan 2008

Tax-free investing is only a generation away

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Contribution limits

Plan Limits

RRSP$24,930 annual limit in 2015

(18% of $138,500)less Pension Adjustment

TFSA $5,500 annual limit in 2015($36,500 cumulative limit for 2009 to 2015)

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Reports on tax-free income

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The RRSP, the TFSA and the Mortgage Chart 1

Benefit after one year from RRSP, TFSA and debt repayment(ROR = 5%, Interest rate on debt = 5%, Tax rate today and upon withdrawal = 33.33%)

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The RRSP, the TFSA and the Mortgage Chart 2

Benefit over one year from debt repayment and RRSP contribution, with varying tax rates upon RRSP withdrawal

(Investment rate of return and interest rate on debt = 5%)

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The RRSP, the TFSA and the Mortgage Chart 4

Benefit over 25 years from an RRSP contribution or debt repayment(ROR = 2%; Debt interest rate = 5%; Tax rate today = 33.33%;

Tax rate at RRSP withdrawal = 20%)

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Estate planning – Testamentary Trusts

Uses for testamentary trusts

Inheritances by minor beneficiaries

– Life insurance trust

Staged distributions

– ½ at age 25, ½ at age 35

Spendthrift beneficiaries

Motivate behaviour of beneficiaries

– Matching incentive trust

Protect kids’ inheritance in case of remarriage

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Inheritance protection using a testamentary trust

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Spouse A

Kids

Spouse B

SecondFamily

Test.Trust

QuestionsAnswers&

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