Owning a business has many rewarding benefits and opportunities. However, tax planning for a business presents many challenges and complexities. Fortunately, there are many techniques for reducing taxes payable by a business. Income splitting allows you to shift income from a high-rate taxpayer to a low-rate taxpayer. An Individual Pension Plan is an investment vehicle designed for the owner of a corporation or an executive that offers higher contribution limits than an RRSP. A Private Health Services Plan is a CRA approved plan to provide medical and dental benefits to employees that are tax deductible to the employer. And, finally, investing a portion of retained earnings in a life insurance policy owned by the corporation will shelter the earnings from taxation and ultimately pay out to surviving shareholders on a tax free basis.
Income splitting is a tax planning technique designed to shift income from a high-rate taxpayer to a lower rate taxpayer such as a spouse or children. Provisions in the Income Tax Act, known as attribution rules, are designed to curtail income splitting. Nevertheless, certain techniques can still be effectively used to shift a certain amount of income or capital gains from high income to low income family members.
- Spousal RRSPs: When a higher-income earner makes a contribution in the name of the lower-income earner, the deduction is applied to the higher-income earner.
- Business Loans: If you make a loan to a family member, including a spouse, to invest in a family business, there will be no attribution of business income to you.
- Fair Market Value Loans: If you lend funds to a spouse or child and interest is paid by January 30th of every year, there will be no attribution of income earned back to you, but your spouse or child is entitled to an interest deduction on the interest paid to you.
Individual Pension Plans
An Individual Pension Plan (IPP) is a Defined Benefit Pension Plan established for the benefit of one individual; typically the owner/employee of a corporation or specific non-owner executive. An IPP generally makes sense only for those owners over the age of 50, although the older the individual, the more significant the plan contributions will be.
A few of the key benefits of an Individual Pension Plan (IPP) are as follows:
- Ability for the company to make a significant tax-deductible lump-sum contribution to the pension plan in the year the plan is established
- Significantly higher annual contribution limits than Registered Retirement Savings Plans (RRSPs), which are also tax-deductible to the corporation
- Broad range of investment options
- Tax-deferred growth of investment income within the plan
- Creditor protected
At retirement, an income is paid from the IPP to the owner/employee which is fully taxable income, just like withdrawals from a RRIF.
Private Health Services Plans
Medical and dental benefits offered by an employer through a PHSP to an employee are tax-free to the employee and tax-deductible to the employer. This often results in a 30-40% savings by having the business deduct the expenses from income, thereby lowering taxes.
The corporate employer or self-employed individual makes tax-deductible deposits to the PHSP for the benefit of the employee/partner/proprietor and their dependents to spend tax-free on qualifying medical expenses. The list of qualifying expenses is very broad, and includes prescription drugs, dental bills, hospital expenses and chiropractic, physiotherapy, massage and acupuncture therapies.
Unincorporated businesses can contribute $1,500 per adult and $750 per child per year for employees and their dependents (there is no stated maximum for corporations, however the amount must be reasonable). Deposits remain to the credit of the employee until they are spent and anyone in the family can utilize the entire balance, as needed.
Another tax planning strategy for business owners is to invest part of the retained earnings in a life insurance policy owned by the corporation. The investment income earned within the life insurance policy is sheltered from taxation until withdrawal (similar to an RRSP), however, if the investments are retained in the policy until the death of the insured, then potentially all of the investments and the death benefit can be paid out to surviving shareholders (such as a spouse or children) on a tax free basis. This strategy can be used to strip assets from a corporation on a tax free basis where it would otherwise be deemed a taxable dividend or capital gain at death.