The Canadian government recently introduced big changes to capital gains in the 2024 Federal Budget. You’re probably wondering how it will affect you and/or your business moving forward. These changes, particularly the increase in the inclusion rate on capital gains from 50% to 66.7%, are significant and require careful consideration to minimize their effects on your financial goals and estate planning strategies.
Here’s what you need to know:
What has Changed
- For individual taxpayers
Income taxes on realized capital gains in Canada are on the rise. In Ontario, for instance, with a top marginal tax rate of 53.5%, the tax on capital gains below $250,000 remains at 26.75%. However, the tax rate on gains exceeding $250,000 has jumped to 35.85%. This change won’t affect most taxpayers who typically don’t realize gains above $250,000 annually. But for those who do, the additional taxes could be substantial.
Take, for example, the sale of a recreational property such as a cottage in Muskoka. If the gain from the sale is $500,000, the tax owed would increase from $133,750 to $156,500 under the new rates. This increase would be even more significant if the property had been in the family for generations.
This scenario also applies to Ontario residents looking to sell rental properties or investment portfolios for a profit. They will now incur an additional $9,100 in taxes for every $100,000 of capital gain that exceeds the $250,000 threshold.
- For corporations and trusts
For private corporations and trusts, the recent changes in capital gains mean that there is no longer a reduced inclusion rate for the first $250,000 of gain. Now, every dollar of realized capital gain is taxed at an inclusion rate of 66.7%.
In practical terms, let’s revisit the example of the cottage. If this property were held within a corporation and sold for a gain of $500,000, the entire amount would be subject to tax at the 66.7% inclusion rate. This would increase the total tax liability to $168,170.
Many professionals derive income through private corporations, allowing surplus income to accumulate for future corporate use. However, the recent tax increases on corporate investment realization and shareholder access to proceeds have been substantial.
Canadian Controlled Private Corporations (CCPCs) can use a tool called the Capital Dividend Account (CDA) to flow tax-free portions of capital gains to shareholders. Due to the higher inclusion rate, the amount of tax-free capital dividends has now been reduced. For example, if a corporation realizes a $500,000 capital gain with a 50.2% tax rate on investments, the corporation’s tax liability would increase to $168,170 from the previous $125,500 with a 50% inclusion rate. Before June 25, 2024, the tax-free capital dividend available to shareholders would have been $250,000, decreasing to $166,500 thereafter. Consequently, higher taxes paid by the corporation mean fewer tax-free proceeds available to shareholders.
Additionally, the higher inclusion rate accelerates the calculation of Adjusted Aggregate Investment Income (AAII) for corporations, impacting the Small Business Deduction (SBD) which offers a lower tax rate on the first $500,000 of active business income. This deduction is reduced by $5 for every $1 of AAII, further affecting corporate tax planning strategies.
Estate Planning Considerations
With these changes to capital gains, estate planning becomes more critical than ever. Upon death, individuals are deemed to have disposed of their capital property at fair market value, potentially triggering substantial tax liabilities for estates holding significant non-registered investments or valuable properties.
Planning Opportunities
To mitigate the impact of higher capital gains taxes, individuals and businesses can explore various strategies:
- Diversification of Investments: Spreading investments across different asset classes to reduce exposure to high capital gains.
- Leverage Personal Inclusion Rates: For owners of private corporations with capital investments, it may be beneficial to transfer some of these investments into personal ownership. This strategy allows you to leverage the lower inclusion rate applicable to the first $250,000 of capital gains, optimizing your tax position.
- Using Permanent Life Insurance to Cover Taxes Upon Death: Permanent life insurance products have traditionally played a crucial role in providing the liquidity needed to cover taxes upon death. Given the potential for higher taxes resulting from increased inclusion rates, it may be wise to consider increasing the amount of life insurance maintained for this purpose. You may also want to reevaluate life insurance owned by your corporation to ensure it meets the liquidity needs of the business owner. The death benefit of the policy, beyond its adjusted cost basis, can be distributed tax-free to the surviving shareholders or family members from the Capital Dividend Account.
Navigating the changes to capital gains requires proactive planning and a thorough understanding of your financial situation. Whether you’re planning for retirement, managing a business, or structuring your estate, let’s meet to discuss your options. We can provide invaluable guidance and optimize your financial strategies in light of these changes.