When the passive income rules came into effect in 2019 the reaction from the business and tax community was understandably not positive. Many saw the change as punishing owners of privately companies for taking risk, creating employment and for being a major contributor to the Canadian economy.
The sliding scale reduction in the Small Business Deduction means that a CCPC with passive income over $50,000 per year starts to lose the small business income deduction. Once Passive Income reaches $150,000 per year the Small Business Deduction is lost. That passive income will now be taxed at the combined Federal and Provincial investment tax rate that is very close to 50%.
What options are available to avoid an increase in the tax burden on passive income?
Two options might be considered; an Individual Pension Plan (IPP) and a Permanent life insurance policy.
The individual Pension Plan does require some set up and ongoing reporting etc. For some it may be attractive.
As part of an overall succession planning process a permanent life insurance contract could be worth considering. It can be flexible, tax efficient today and a unique, succession planning tool in the future.
Here is an example of a couple who decided to examine the permanent life insurance option:
Roger and Susan, both 65 years old, non-smokers.
The couple owns a holding company with $1 million sitting in a GIC, earning 5% annually. The couple doesn’t need this money to support their lifestyle, and plan on passing it on to their children.
The couple also have an operating company, but the growth in their GIC may start to erode the small business tax rate.
Since the couple doesn't need to access the money to support their lifestyle, they allocated $100,000 per year for the next ten years into a tax-exempt last to die insurance policy. This type of policy is a perfect tool to provide estate obligation liquidity just when it is needed. Because of the actuarial calculations these types of policies can be very attractively priced.
The money inside the policy will grow tax free. If we use a major Canadian insurer’s whole life policy on a joint, last-to-die basis at age 85 there would be a death benefit of $2,667,776. If both spouses die that year, the corporation would receive a credit to the CDA of $1,971,005.
The couple’s estate would net $2,341,409 after tax.
We compared the insurance based solution to keeping the $1 million money invested in a GIC at 5%.
To get the money out of the corporation, the couple would have to pay annual tax on the growth as well as a dividend tax. Their estate would only net out $933,574. That’s more than $1.2 million lost to taxes. A big difference!
When comparing the GIC option to the insurance option, there’s a 151% advantage in the amount of money the couple would end up with – and that’s before any other financial planning.
The insurance solution has many potential benefits:
Flexibility; the client can access the funds by withdrawing funds or assigning the contract to fund business activities or supplement retirement income. Flexibility and control are key attributes of these policies.
Mitigation of the passive-income rules. The funds inside the contract grow tax free
Tax-sheltered growth of the cash value. In the case of whole life, equity-like returns with a guarantee of no negative returns.
A mechanism to get money out of the corporation tax free at death using the CDA
A much larger estate benefit for the surviving family.
Given the very real benefits of using a permanent life insurance policy as a financial and small business tax planning tool, it’s definitely worth having a conversation about life insurance.
When was the last time you did?
A short conversation might help determine whether this strategy is the right planning tool to keep more money in the family business.
John Wordsworth can be reached at 604 639 3136 or by arranging a short conversation here