Higher levels of personal income are taxed at higher personal rates, while lower levels are taxed at lower rates. Therefore, individuals may want to, where possible, adjust income out of high income years and into low income years. This is particularly useful if the taxpayer is expecting a large fluctuation in income, due to, for example,
- taking maternity/paternity leave;
- receiving a large bonus;
- selling a company; or
- planning on selling or buying investment assets.
In addition to increases in marginal tax rates, individuals should consider other costs of earning additional income. For example, an individual with a child may give up some financial support from the government in the form of reduced Canada Child Benefit (CCB) payments if the individual earns additional income in a certain year. Likewise, excessive personal income may reduce receipts of Old Age Security, and GST/HST credit.
There are a variety of different ways to smooth income over a number of years to ensure an individual is maximizing access to the lowest marginal tax rates. For example,
- In owner/managed companies, owners may take more, or less, earnings out of the company in the form of salaries or dividends. The best option depends on the applicable provincial/territorial tax rates, and quantity of personal and corporate income, amongst other factors.
- Realizing investments with a capital gain or loss in the year.
- Deciding whether to claim RRSP contributions made in the current year, or carry-forward those contributions.
- Deciding on whether or not to claim CCA on assets in a proprietorship.
- Withdrawing funds from an RRSP to increase income. Care should be given, however, to the loss in RRSP room based on the withdrawal.
- Consider electing to pay out tax-free dividends from the “Capital Dividend Account” in years where an individual is in a high marginal tax rate.
Changes in provincial/territorial rates may also impact the above decision.
There are also some year-end planning possibilities available which do not specifically relate to changes in income levels and therefore marginal tax rates:
- Spouses may jointly elect to have up to 50% of certain pension income reported by the other spouse.
- Consider paying taxable dividends to obtain a refund from the “Refundable Dividend Tax on Hand” account in the Corporation.
- Corporate earnings in excess of personal requirements could be left in the company to obtain a tax deferral (the personal tax is paid when cash is withdrawn from the company).
- The effect on the “Qualified Small Business Corporation” status should be reviewed before selling the shares where large amounts of capital have accumulated.
- Dividend income, as opposed to a salary, will reduce an individual’s cumulative net investment loss balance thereby possibly providing greater access to the capital gain exemption.
- It may be advantageous to defer receiving Old Age Security receipts (for up to 60 months) if it would otherwise be eroded due to high income levels (greater than $73,756 for 2016).
- Salary payments require source deductions (such as CPP, EI and payroll taxes) to be remitted to CRA on a timely basis.
- Individuals that wish to contribute to the CPP or a RRSP may require a salary to create “earned income” RRSP contribution room increases by 18% of the previous years’ “earned income” up to a yearly prescribed maximum ($25,370 for 2016; $26,010 for 2017).
- If you are providing services to a small number of clients through a corporation (which would otherwise be considered your employer), CRA could classify the corporation as a Personal Service Business. There are significant negative tax implications of such a classification. In such scenarios, consider discussing risk and exposure minimization strategies with your professional advisor.