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Tax Planning for the Ontario “Wealth” Tax

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We’ve heard a lot from the “99 per cent” over the last year. But a few months ago, Ontario’s government passed a bill aimed at the other “1 per cent.”

On June 12, Queen’s Park approved a 2% tax increase on those who have a taxable income over $500,000. This increase will be implemented gradually. The first percentage point hike came into effect on July 1, 2012, and the second percentage point will hit in 2013.

When you add it up, the highest combined federal and provincial tax rate in Ontario will be 47.97% in 2012 and 49.53% in 2013.

It looks like the new tax will only impact the top 1% of earners in the province…but I think it’s useful to see how income tax changes can affect income tax planning, even if you’re part of the other 99%.

One option for high earning unincorporated professionals, like a doctor, for example, is to include the use of professional corporations to carry on the individual’s professional practice. This can offer a significant tax deferral advantage. Some of the individual’s income can be kept in the corporation, and isn’t required by the professional to meet his personal needs.

Here’s how the deferral works. The corporation would only pay about 15.5% in tax on the first $500,000 of active business income and about 26% on income above that. That’s much lower than the forecasted 49.5% that would be paid personally after the new Ontario wealth tax is fully implemented.

If the corporation is set up properly, it can also facilitate income splitting among the taxpayer’s family members, reducing the family’s overall tax burden.

High earning individuals can also invest surplus income in a holding corporation. This wasn’t an attractive option before because of the refundable tax system we have in Canada. But with the implementation of the “wealth tax” comes tax deferral opportunities for those who earn investment income through a corporation.

After the “wealth tax” is fully in place, the effective integrated tax rate on investment income will be 48.86%. Compare that, again, to the 49.53% personal rate.

High-income earners who currently make a lot of money on their investments can income split with a lower-income earning spouse, or children and grandchildren. One way to do this is to make a prescribed rate loan (currently at a historical 1% low) to a family trust or spouse, so you can shift investment income to the borrower. This lets the borrower invest the money. The difference between the rate of return on that money and the 1% paid to the lender will be taxed in the hands of the borrower, not the lender.

We know we’re only talking about the 1% here. But a closer look at this tax can help anyone see how good personal and business tax planning combined with strong advice can reduce an increasingly severe tax burden.

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