With regards to incorporation, it would allow retained earnings to grow at a lower tax rate. As mentioned in the article, as soon as money is withdrawn, the taxation equals out. In your situation, it might work out for the better as your wife already works and has an income. Of course, you would have to work out the numbers yourself or with an accountant first.

I believe awhile back you had a link to a John Chow blog post about setting up your blog as a corporation. According to John Chow, an individual with no other income can withdraw about $33k per person ($33k for himself & $33k for his wife per year) tax free as dividends per year and have the corporation being taxed at about 15%. Maybe you might want to write another blog entry following up on John Chow’s blog entry on the topic.

Can anyone suggest a good accountant that they use in either Vancouver or in Calgary?

The biggest advantage of a corporation is being able to flow expenses through and pay them with pre-tax dollars. The larger your business is, the easier it is to flow more and more expenses through that you would normally have to pay with after-tax dollars and easily justify them in the eyes of CRA as being legitimate business expenses. The real advantages start to occur in the $100k-$500k revenue range. Below that and whatever you manage to save will just get eaten up with added corporate fees (accounting, legal, etc).

What about scenario 2, then, retaining earnings in your corp until you get enough to purchase a business when you then sell all the shares for your $750K capital gains exemption?

Only at the time of sale, does 90% of the assets have to be engaged in active business.

And if you only do this once (just before you cash out) in the entire lifetime of your corp.. that’s hardly habitual, and I’m sure you can manage the optics to make it appear as if you were ‘intending’ on running it as a real business.

The advantage to this is that you only pay corp tax on your retained earnings and some transactional fees for buying the business in the middle (which I suppose, can be large or smaller depending on how well you negotiate).

Does this make sense?

Just to draw your attention to CRA IT-218. http://www.cra-arc.gc.ca/E/pub/tp/it218r/it218r-e.html It discusses whether the sale of property is a capital gain, or business income

Drawing your attention to two sections the CRA can treat habitual property flipping as business income.

5. A taxpayer’s intention at the time of purchase of real estate is relevant in determining whether a gain on its sale will be treated as business income or as a capital gain. It is possible for a taxpayer to have an alternate or secondary intention, at the time of acquiring real estate, of reselling it at a profit if the main or primary intention is thwarted. If this secondary intention is carried out any gain realized on the sale usually will be taxed as business income.

6. The more closely a taxpayer’s business or occupation (e.g. a builder, a real estate agent) is related to real estate transactions, the more likely it is that any gain realized by the taxpayer from such a transaction will be considered to be business income rather than a capital gain (see 3(f) and (j) above).

For example, my university tax prof used to talk about the hard luck farmer who would buy properties, discover they’d be marginal for farming but he’d “find” tonnes of gravel on the property and sell them for a large (capital) gain. The CRA caught him because he was expensing geological survey reports.

If I tried to do this as a real estate person sole propietor, I’d have to pay 50% of my marginal rate on each flip, which would mean there’d be up to a 20% tax rate on each flip. Which means I’d have to flip 6 and a bit times.

Which, in the scheme of things, probably isn’t a big deal. What’s one more flip if you’ve done it 5 times already?

It is a “safer” approach to income splitting than employing your spouse or kids since CRA will not engage in a reasonableness test for the payment of dividend but when you employ a family member CRA will look at how much you paid your spouse in relation to the work done (since people abuse this income splitting move).

FT: The advantage of dividend payments and dividend sprinkling is that it is at the discretion of the directors assuming after the corporation can meet its obligations as they become due after the payment of the dividend (the only real test of declaring a dividend). Thus, if in any given year, you are better off claiming the spousal credit, then don’t declare a dividend and keep the money in the business or sprinkle the dividend to another class of shares rather than the shares owned by your spouse. Dividend sprinkling, however, is usually only done when the corporation has a lot of free cash flow.

Let’s say I had 300K invested in my corp. I bought a business (non corp, unless I wanted to hold it for 24 months .. right?), prettied it up, and flipped it for 360K. The corp only has to pay 50% of the gains as taxes, right? The business would go under the heading of ‘eligible capital property’, correct?

Now, let’s say I did that several times, until I reached my upper limit exemption of 750K.

Then I sold the whole kit and kaboodle.. Nothing goes to the tax man, correct?

I parlayed 300K into 750K, paying only a 9% tax rate along the way of each flip.

Am I missing something here? Gaar, maybe? I don’t think Gaar gets called upon that often, from what I know. It’s a pretty sucky law (it’s tax avoidance if we say so)

Good point about the spousal amount- that would wipe out a good portion of the savings. However, if the wife had a low income rather than no income, I’m thinking it wouldn’t make a difference.

Another issue is that the added income would take away from the spousal credit. I would need to work out the numbers to see which case is more tax efficient.

Let’s say that in the first scenario, Jim’s wife is a stay-at-home mom with minimal income. Rather than distributing dividends to Jim, the full $10k could be distributed to his wife. Rather than being taxed at Jim’s higher rate, these would be taxed at her lower rate of 4.35%, saving the couple $3,723.

I know that there are a few traps to this approach, but my understanding is that this is a viable option. Anybody with more expertise care to correct me on this?

It also bears mentioning that pre-incorporation expenses and money put into the business by the owner-manager before it was profitable can be classified as a shareholder loan to the corp. and with-drawn tax free (assuming that the loan to the corp. was using after-tax monies). An accountant can set up the proper ledgers to support this method of with-drawing money.

Retain all the earnings you want to reinvest in the business. Then pay yourself a salary upto the max for CPP. Then dividends for any additional money you want to take out.

I dont know the facts or figures around that rule of thumb, just that she said it and she’s been an accountant for a very long time..

-MikeG

That is a doubly big if, as the shares of the company must be sold. If it is a sale of assets, then the rule does not apply, unfortunately. This can make big difference in your tax planning, but your crystal ball has to be in fine form to make the prediction. The second ‘if’ is of course that you have created a business that another sees sufficient value to purchase, rather than parallel it by creating a competing business.

Reference: http://www.taxtips.ca/smallbusiness/capitalgainsdeduction.htm

DAvid