Author: Chantel Gibbs

Being incorporated vs self-employed

Posted on by Chantel Gibbs

Being Incorporated vs Self-Employed

Let’s say you start a small business. One of the first questions people often have is whether to incorporate their business because they have heard that incorporation can defer taxes and shield the owner from creditors who might sue the business. While this is true in most cases, the benefits of incorporation depend largely on the profits made by the business and being incorporated won’t necessarily shield the owner from liability if a lawsuit is due to the owner’s personal negligence. So when should you consider incorporation?

First, you need to consider the type of business you are in. A lot of larger businesses like to hire contractors because it is much simpler than having an employee and the contract can be easily terminated after the project is finished. If your business is mainly sub-contracting your skills out to larger companies, then you need to be working for multiple companies in a year, otherwise CRA will consider you to be a glorified employee. They may also chase the business who sub-contracted to you for employee remittances because they should have just hired you as an employee. To be properly sub-contracted, you need to have your own tools for the work, show that your hours are based more on deadlines for the project than the business’ usual office hours, show that there is an expected end date to the contract, and that you are available and taking contracts from other businesses.

An incorporated small business is a separate legal entity from its owner and that means that it files a separate tax return and separate financials from the owner every year. This is a significant additional cost, so the amount of deferred profit in the company and resulting tax savings must be worth that cost. Also, the incorporated small business must not be treated as the owner’s personal bank. Anything that the company pays for that is used personally must be declared as either salary or a dividend to the owner and taxed in the owner’s hands. This is an area that CRA particularly likes to audit and the penalties are steep.

The following table is a comparison of some differences between being incorporated and being self-employed.

There are many things to weigh in the decision whether to incorporate or not and much of it depends on personal circumstances. Please reach out for an appointment if you would like to discuss your own business.

The Basics of Life Insurance

Posted on by Chantel Gibbs

The Basics of Life Insurance

There are two main kinds of life insurance and they are suited for different purposes. Temporary life insurance provides coverage for those years while raising a family and needing to protect family income. Permanent life insurance can be both an investment and a way to pass assets on to heirs or pay final taxes.

Term Life Insurance is life insurance that has a set premium for a specific number of years and then renews at a higher amount after that. It can usually only be renewed up to age 85. For example a Term 10 policy is usually very inexpensive for the first ten years, then it renews at a higher premium for the next ten. Eventually, it becomes more expensive than a permanent policy taken out at the same time. That’s why a term insurance policy is best for temporary coverage.

Whole Life Insurance is a permanent kind of insurance with a cash value that grows over time as more money is invested into the policy and the insurance company makes a return on the investment. The policy can be paid for over 10 years, 20 years, or a set premium every year for life. In retirement, the cash value can be leveraged with a line of credit, providing some tax-free income. At death, the insurance company first repays any outstanding loans on the policy and then pays the remaining death benefit to the named beneficiaries. Whole life is a great way to make some tax-free investment returns as well as provide a benefit to heirs on death.

Universal Life Insurance is a flexible kind of permanent insurance. It works best for a person who has a set amount they want received at death and they aren’t looking for substantial growth in the death benefit. It has the flexibility to be minimally funded or funded with more than the minimum premium and invested tax-free to help pay for future premiums. It can in many circumstances be less expensive than a whole life policy.

If you are interested in life insurance, I can help you pick out what would most suit your needs. I also have access to the major insurers in Canada and can provide you a quote with the lowest cost out of those insurers. 

 

Bypassing the Estate

Posted on by Chantel Gibbs

 

Bypassing the Estate

There are several good reasons for trying to pass on assets outside of the estate. Probate fees in BC are a percent of the entire estate, not just a flat fee. It typically amounts to 1.4% of the assets, so a $1,000,000 estate would have $14,000 in probate fees. The probate process typically takes about 6 months while the estate is on hold until any potential creditors are notified and family members are given an opportunity to contest the will. This might mean that assets are frozen until probate is concluded. Also, the probated will is a public document that anyone can access from the courts for a small fee.

The downside of bypassing the estate and the will, of course, is that the will carries no authority over those assets, so the person’s assets may not be distributed according to their wishes. In one case I was told about, a daughter was named as the beneficiary of the RRSP and TFSA accounts and was on joint title for the home. The will said the estate was to be divided equally between all children. When the last parent passed away, most assets rolled over to the daughter with very little actually passing through the estate. The daughter shared nothing of those assets with her brothers. This likely was not the parents’ intention.

The below table documents a few ways to bypass the estate and the pros and cons of each method. It is important to consider any unintended consequences of having an asset bypass the estate and go straight to a beneficiary.

 

 

Estate and legacy planning becomes especially complicated in the case of a second marriage or blended family. For tax reasons, it is encouraged to roll assets to a surviving spouse and defer all tax until that spouse passes away, but in a second marriage, the question becomes whether that spouse will then give the children from the deceased spouse an inheritance or not. In some situations, the use of trusts or specially segregated accounts can help to ensure assets go to the children of the first marriage.

As always, please contact me if you would like help creating your own estate and legacy plan.

When to Apply for CPP and OAS

Posted on by Chantel Gibbs

When to Apply for CPP and OAS

The optimal time to apply for the Canada Pension Plan (CPP) payments and the Old Age Security (OAS) is different for everyone and largely depends on when income from other sources like employment decrease or stop. For instance, if you work up to age 65, it is likely best to wait till then to apply for the government pensions. If you are selling your business and winding things up and still expect some taxable income after 65, then it might be worth delaying as far as age 70. All amounts received under the CPP and OAS are taxable and will add to your taxable income for the year.

Canada Pension Plan payments are based off your prior contributions from your salary over your working years in Canada. It automatically excludes your 8 lowest income earnings years from the calculation. Also, if you earned little or no income while raising young children, the calculation for those years will be based on the five years before having children. The child rearing benefit needs to be applied for at the same time as applying for CPP in general.

The maximum retirement benefit paid by CPP in 2020 is $1,175.83 per month at age 65. CPP can be applied for as early as 60 years of age or as late as 70. If taking it early, there is a 0.6% penalty per month on the amount received (ie. if taken 10 months early, you would receive 6% less) and there is a 0.7% bonus if delayed after 65 (ie. if taken 10 months later, there would be a 7% bonus).

Old Age Security is based simply on how long you have lived in Canada. If you have been here for over 40 years before applying, you will receive the full amount of $613.53 a month at age 65. The OAS is income tested and starts to be clawed back at $0.15 for every $1 made over the prescribed limit if a person makes too much taxable income (over $79,054 in 2020).  Delaying the OAS after 65 will give a 0.6% bonus a month on the amount and will increase the taxable income threshold before it is clawed back. Most people will receive a letter automatically enrolling them in OAS at age 65, but if you choose to delay it, you can do so at Service Canada or with your online Service Canada account.

For low income earners, there is an additional OAS benefit called the Guaranteed Income Supplement (GIS) to make sure seniors have at least a minimum income level. It is based on household taxable income and varies for singles and couples.

Death and Taxes

Posted on by Chantel Gibbs

TIPS FOR REDUCING TAX AND FEES

  • Have a will signed and in a place where the executor can find it
  • Try to use up your RRSP / RRIF savings before life expectancy. Put extra in the TFSA instead.
  • Have an exit plan for your business
  • Keep your will simple. Specific gifts can be done outside the will.

DEATH AND TAXES

In Canada, we do not have an estate tax like in the US, but that does not mean there are no tax consequences at death. A resident of Canada who dies is deemed to have disposed of everything they own at fair market value, so if there was any gain in value on property or stocks, that gain would all be taxed in year of death. Even worse, any amounts left over in a retirement account like a RRSP / RRIF would all be added to income. Imagine a person passing away with $400,000 left in their RRSP. That would be $400,000 extra taxable income in year of death! In BC, anything over $220,000 income is taxed at 53.5%.

It gets even worse for an incorporated small business owner. If the business has increased in value, at death there is a capital gain on any shares held by the owner. The problem is that to take money out of the company, it is a dividend, which is a completely different layer of tax. Unless the executor can find someone to buy the shares directly from the estate, there will be double tax on the value of the business shares held by the estate – first the gain on the shares, then the dividend to strip the value out of the company and wind up the business. Only exception is if the company itself buys back the shares from the estate for a deemed dividend within one year of death. Then the capital gain portion of the tax can be avoided.

The main exception to the deemed disposition rules is if the deceased had a spouse that inherited the assets. The tax rules allow for a rollover at original cost to a surviving spouse or common law partner. This could include the RRSP, TFSA, investment property, and business shares amongst other things. The tax would then be avoided until the surviving spouse passes away.

Income tax isn’t the only tax a person can face at death. Each province in Canada has its own fees for overseeing the will. In BC, that fee is about 1.4% of the entire value of the estate. For an estate worth $1,000,000, that would be a fee of about $14,000.

There are ways to have amounts bypass the will and go straight to a beneficiary, avoiding the provincial fee. There are also ways to plan to reduce your estate income tax or the double tax on a corporation. Every person’s situation is different and needs to be carefully considered.

Contact me to discuss how a legacy plan can save tax and administration costs and help make sure your stuff goes to the people you want it to go to.

 

What do you need to save for retirement?

Posted on by Chantel Gibbs

What do you need to save for retirement?

 

The amount needed for retirement is different for every person because it depends very much on what amount that person wants to be able to spend every year. Some people have very simple pleasures while others enjoy travelling in style. It will also depend whether the person is single or not. The spending is higher for two people, but that can be offset with tax savings from being able to split income.

The following chart is an estimate of how much needs to be saved in order to have a certain spending level in retirement. This assumes that $20,000 is provided through the Canada Pension Plan and Old Age Security. You will notice that it increases disproportionately the higher the spending is. This is because higher spending usually means a higher taxable income, so more of the savings are having to go to tax, leaving less for actual spending.

 

 

If this is giving you a sinking feeling, remember that you may not spend as much in retirement as you are right now. You may currently be supporting a mortgage that will hopefully be paid off in retirement. You may also be supporting children or aging parents. The trouble usually comes when debt gets carried away and when a person spends beyond their means.

As an advisor, I highly recommend that people set up systematic savings plans if they have a tendency to spend whatever comes in to their bank accounts. It takes discipline to say no to buying things that aren’t essential. Setting up a budget and putting in a set amount for extra things like eating out can help to manage the spending while also rewarding your hard work. Delayed gratification can be sweeter than just feeding whatever desires come up in the moment. Is a cold drink more gratifying after a hike or when sitting on a couch watching Netflix?

If you would like help planning for retirement or just planning your cash flow in general, please don’t hesitate to check out my services and contact me.

 

A Brief Summary of Registered Accounts

Posted on by Chantel Gibbs

A Brief Summary of Registered Accounts

In Canada, there are two categories of accounts for saving money in: registered accounts and non-registered accounts. Registered accounts like a RRSP, TFSA, and RESP are registered with the government and need to follow certain rules in exchange for specific tax breaks or government grants. Non-registered accounts include basic savings and checking accounts and investment accounts. Below is a summary of the main kinds of registered accounts and how they work.

Tax Free Savings Account (TFSA)

A TFSA account allows a person to make investment income tax free. Contributions are made with after-tax money (unlike the RRSP) and the maximum contribution room increases yearly for everyone over age 18. If money is withdrawn one year, the contribution room comes back the next year so they can put the money back in again. It is a great tool for saving for a big purchase or even for retirement. To find your TFSA contribution room, log in to your CRA My Account. If you are a US citizen, you should not open a TFSA because the US does not recognize it and will still tax you on any income made in it.

Registered Retirement Savings Plan (RRSP)

RRSP and Locked-In Retirement Accounts (LIRA) are a way to defer some of your income from your working years to your retirement years. The maximum you can contribute to these accounts is 18% of your earnings up to an amount that the government sets yearly. Contributions are a deduction from taxable income and withdrawals are an addition to taxable income. The difference between the two accounts is that a LIRA or LIF account is a locked-in fund meaning that only a set maximum can be withdrawn every year based on age. An RRSP, on the other hand, has no maximum withdrawal cap and can be drawn from at any time, even before retirement. A RRSP must be converted into a RRIF at the end of the year the person turns 71. After that, a minimum amount must be drawn yearly based on age. Your personal RRSP contribution limit can be found on your notice of assessment or your CRA My Account. If your employer is contributing to a pension plan for you, your RRSP contribution limit will be reduced by those amounts.

 

Registered Education Savings Plan (RESP)

A RESP account allows someone to save for the future education of a family member or even themselves. Government grants are available if the RESP is set up for someone under 18 with a valid SIN number living in Canada. The province of BC also offers a one time grant for children between 6 and 9 years of age. There is a lifetime maximum of $50,000 per child that can be contributed to an RESP. If the child doesn’t attend post-secondary education and there is no sibling to transfer the money to, the plan can be wound up and the money given back to the contributor, but the government grants will need to be repaid.

Registered Disability Savings Plan (RDSP)

A RDSP account is particularly for individuals who qualify for the disability tax credit and have long-term disabilities. The government provides grants to help match what is contributed to the individual’s plan up to a certain amount a year. A lifetime maximum of $200,000 can be contributed to a RDSP. Contributions can be made up until the beneficiary turns 60. Family members’ RRSP accounts can be rolled in to an RDSP account without the usual tax consequences at death, but RRSP rollovers are not eligible for matching government grants.

 

Government Support and Helping Yourself

Posted on by Chantel Gibbs

Government Support and Helping Yourself

If the 2020 coronavirus pandemic has taught us something, it is that many of our jobs are fragile and the government will only offer limited support. Businesses need to be prepared to deal with a sudden loss of revenue and adapt quickly.

If tragedy befell you in your personal life, what kind of support could you expect the government to give? The simple answer is that the government will give you just enough money to sustain basic living. The rest you would need to source from your own assets, your own insurance, or from friends and family.

The CPP Disability benefit is a taxable benefit available up to the age of 65 for severe and long-term disabilities. The benefit is based on how many years contributions have been made to the CPP and how much. There is also a benefit available for the children of a person who qualifies for the CPP Disability benefit.

Employment Insurance (EI) provides a sickness benefit for up to 15 weeks if unable to work due to sickness. To qualify, the person must have 600 hours of work at the job and apply within a short time of stopping work. It is a taxable benefit that only covers part of the salary. Insurance is also available, of course, in the event of a lay-off or loss of work for reasons other than being terminated for just cause. During the Covid 19 crisis, there are EI benefits available for anyone who has been unable to work for 14 days or more.

The Workers Compensation Board (WCB)  pays short term or long term benefits to people who are injured on the job. The payments are intended to cover up to 90% of a person’s after-tax income. Payments are reduced for any other insurance coverage or government benefits you may receive.

On death, CPP Canada will pay a one-time benefit of $2500 to the estate of the deceased. If the person was a CPP contributor, the surviving spouse and children could qualify for monthly support payments from the CPP.

Individual provinces also have their own long-term disability programs that are often asset tested. For instance, BC’s program only allows a person to have a primary residence, one vehicle, and up to $100,000 of savings apart from an RDSP or RESP account to be eligible.

In conclusion, it is best to combine reliance on government programs with your own insurance. This may be partly provided by your employer’s benefit plan, but it may also require buying your own. Most insurers, however, still require you to fund the first few months of loss of income, so you should have an emergency fund in any event.

  • The government will only give you enough in the long term to sustain basic living
  • Short term benefits for sickness are more generous, but still only cover part of prior income level.
  • There is nothing available to businesses to weather an economic storm unless the government specifically sets up bailouts.

 

 

 

 

 

 

Managing Your Taxable Income

Posted on by Chantel Gibbs

Managing Your Taxable Income

 

“Managing your taxable income is important for social benefits like the Old Age Security and to reduce your overall tax expense.”

 

 

 

Many people have the misconception that once you cross into another tax bracket, all your income is taxed at that higher rate. In reality, it is only the income portion that crossed the threshold that is taxed higher. Part of cash flow planning is keeping your taxable income at a consistent level.

Things that could increase your taxable income for the year include draws from your RRSP and the realization of gains on the sale of an investment property or company share.

Earnings that make up ordinary income include employment income, business income, net rental income, interest, pension, RRSP / RRIF withdrawals, CPP, and Old Age Security. Ordinary income is subject to the highest rate of tax.

Dividends received from Canadian companies are taxed lower because the company has already paid some tax on the earnings. For eligible dividends, the company already paid 27% tax, so if the person has taxable income below $48,535, he/she can actually receive a tax refund by earning some eligible dividends.

If you know you will have a large income inclusion in one year, plan ahead to use available tax deductions. For instance, if selling a rental property with a large increase in value, it may be a good idea to keep some RRSP contribution room for that year since RRSP contributions are a deduction from taxable income and can be used to offset the capital gain income inclusion.

Tax credits do not reduce your taxable income, but help to reduce the tax you have to pay. Tax credits include donations, medical expenses, disability, basic personal credits, and many others. Be warned that social benefits like the Old Age Security are based on taxable income, regardless of how much credits you may have.