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PARTICIPANTS
Evelyn Jacks
Founder and President of the Knowledge Bureau
Mark Witte
Regional Vice President
Mark Brisley: You're listening to On The Money with Dynamic Funds. From market insights and analysis to personal finance, investing, and beyond, On The Money covers it all, because when it comes to your money, we're on it.
Mark Witte: Welcome to another edition of On the Money I’m your host Mark Witte. Today we're going to have a critical conversation about the new capital gains tax landscape which is causing significant concern for individual investors and corporate owner-managers. Joining me is Evelyn Jacks, one of Canada's most respected educators in tax and financial literacy and a best-selling financial author of 55 books and publisher of numerous courses on personal, corporate, and trust planning.
An influential business leader, having twice been named one of Canada's top 25 Women of Influence. To set the stage, the April 16th federal budget introduced several significant tax changes, the most important of which is the capital gains inclusion rate moving from 50% to 66.67%. In this broadcast, we're going to look at this new tax landscape, how it will affect individual investors and small business corporations, together with some important changes for real estate owners to consider and what taxpayers can do to maximize and preserve wealth. Evelyn, welcome and so nice to have you here today. Can you please give us a backdrop to the story?
Evelyn Jacks: Yes, thank you, Mark. The financial reality for the government now till the end of this decade is somewhat grim. Despite budgetary revenues being slightly higher than projected expenses by 2029, the reality is that our public debt charges are increasing dramatically. Imagine, in 2023, those public debt charges were $35 billion, but every year until 2029, that's increasing, $47 billion, $54 billion, $64 billion by the time we get to 2028/2029.
What that means is that taxes have to go up. The big announcement in the April 16th federal budget was, of course, something we should have anticipated. We've talked about it before, but it was a surprise; that is, indeed, the capital gains inclusion rate, which is currently 50%, is going up to 66.67%. That's going to cost Canadians on their personal tax, corporate tax, and non-resident taxes by 2029 about $53 billion more, 16% more. That comes at a bad time, particularly for corporations, which have seen a really big dip in their profits, especially in 2023/2024. The government now is going to shore up its own revenues by increasing the tax on capital gains.
Mark: The capital gains inclusion rate will rise for dispositions on or after June 25th, 2024, but the rules are different for corporations than they are for individuals, correct?
Evelyn: Yes, that's right. The capital gains inclusion rate will rise for dispositions on or after June 25th, 2024, but the calculations are going to be different for corporations than they are for individuals. Individuals will only see that rate increase on their capital gains over $250,000. What that means is the marginal tax rates are about to change on capital gains incurred by individuals, and the increase is going to be just under 9% overall. When we look at this, there are going to be other issues that we're going to deal with. For example, there will be clawback zones on other provisions that may be affected by some taxpayers.
For many high-net-worth individuals, they won't qualify for the age amount or old age security anyway. There's another significant factor, and that's the alternative minimum tax.
Mark: There are many people who have real concerns about the gains in their cottages and vacation homes. Those held in families that were acquired decades ago on quiet lakefronts that are now popular tourist attractions will have appreciated significantly. British Columbia's Okanagan Valley 25 years ago did not have the appeal it has today. Victoria, British Columbia, where a home in 1986 cost as little as $66,000, now has a lot value at over $1 million. Calgary's inner city communities where in 2001 townhomes could still be found for $95,000 today sell for $460,000. What can be done, Evelyn?
Evelyn: There's a couple of things to think about. For second personal residences, for example, is this the right home being designated as the principal residence? What's required is that if you have a home in the city and a home in the country, perhaps a vacation property, you must ordinarily inhabit each one of those properties for some time in the year. If you do that, then you can choose either property to be your tax-exempt principal residence. Now, another thing you can think about is, will prices dip with higher taxes going forward? With mortgage rates perhaps rising for some homeowners, is this the right time to sell or is this the right time to make improvements?
Remember, improvements will bump up the cost base in your properties and reduce capital gains down the line when property valuations may be lower. We need to really sit back and think about what the right property is and also where have all the improvements landed to really understand what the capital gains taxes are going to be.
Mark: How about an example, Evelyn? Let's assume we have a million-dollar cottage with a cost base of half a million. How much more will this taxpayer pay after June 25th?
Evelyn: Prior to June 25th, the taxable capital gain in this case would be $250,000 at the 50% rate. After June 25th, the taxable gain is about $41,750 more. This taxpayer will pay close to $14,000 more federal taxes than they did if the property would have been sold before June 25th. In addition to that, we have to be mindful of the alternative minimum tax, which this taxpayer may also be subject to.
Mark: What is that minimum tax?
Evelyn: In Canada, we calculate a regular tax, which applies to most people, including high-net-worth individuals. The cottage disposition may put a taxpayer into the top tax bracket, and that means at 33% federal tax rate. Now the alternative minimum tax will apply if the taxpayer's adjusted taxable income on the minimum tax calculation is over $173,205. In that calculation, various tax preferences are added back into the calculation of tax, and that includes the preferred capital gains tax treatment. At the end of those calculations, whatever is the higher tax, the minimum tax, or the regular tax is what the taxpayer will pay.
A special note on the minimum tax, you do have seven years going into the future in which you can claim the minimum tax back against regular taxes payable. The alternative minimum tax, or the AMT, has also been under construction. In provisions introduced in 2023, most non-refundable tax credits that you claim on the regular tax return will now be cut to only 50% on the AMT calculation. This particular move was met with considerable consternation, particularly as it relates to claiming of donations. The government has backed down somewhat and will allow the taxpayer to claim 80% of their charitable donations on their alternative minimum tax calculation.
All of this to say, you still are going to pay a little bit more tax if you're subject to AMT if you are someone with high income who makes large donations.
Mark: Right. The numbers will really tell the story, Evelyn, and it's important for investors to run through them with their financial advisors and accountants before crystallizing gains.
Evelyn: For most people, the alternative minimum tax, or the AMT, will be lower than regular taxes. If AMT is payable, one good thing, as mentioned, is that we can use it to offset regular taxes in the future, in fact, over the next seven years. There's a chance of getting that AMT, or alternative minimum tax, back. It does expire with the death of a taxpayer, and it's not transferable. If you're looking at people who have a shortened lifespan, make sure that you take that into consideration (in planning income before death and on the terminal return).
Mark: It would appear all of this brings a lot of new complexity to the filing of a tax return.
Evelyn: Yes, and as I mentioned, this relationship with your financial advisor and your tax accountant is so significant. Just consider the calculation of the application of capital losses, for example. Because the capital gains inclusion rate is going up to 66.67%, any capital loss is being carried forward to reduce capital gains after that capital gains inclusion rate goes up, will have to be grossed up, and that's a new calculation. Now when we think back at prior year losses, they will have to be grossed up as well. If you've held onto the asset for a long period of time, back in the '90s we had a 75% capital gains inclusion rate, and so there'll be a second gross up to take into account those losses.
In the case of small business owners, there's more complexity because there are potentially six different capital gains exemptions to consider when you are thinking about selling your business over a 40-year holding period. I can't even begin to explain to you how mind-boggling these calculations could be. Suffice it to say, start early to consider your planning and to think about whether or not before or after June 25th is the right time to sell (trigger a disposition).
Mark: What should an individual do?
Evelyn: I think the first step is to do a really great net worth calculation. Let's get it up to date. Let's get all our valuations up to date, not just from our portfolio, but our real estate and business assets. Begin with reviewing your portfolio with your advisor and think about how you can manage capital gains as an individual to stay below the $250,000 threshold annually. Remember, if you do some income splitting and your assets are in the right hands, in a household, that's $500,000 of capital gains split equally between a couple. Sell assets with the highest gains first, perhaps, but offset those with losses.
If you're thinking about your highest gains offset by losses, can you average down that portfolio and those dispositions to stay under the $250,000 threshold in either spouse's name? Let's think about that. Where are the highest gains and where can we offset them by losses? Also, if you're settling on selling something in your portfolio, remember the date really isn't June 25th for you. It's going to be June 21st or perhaps the 20th in order to settle the actual transactions on time. Another consideration, if you have U.S. securities, are there going to be currency fluctuations to take into account? Remember, in Canada, we have to report world income in Canadian funds on our income tax return.
Lots of things to think about just from the point of view of analyzing the best results within the portfolio itself. Longer term, if you are trying to transfer some assets into your spouse's hands, remember there are the attribution rules to think about. You can't simply do that because the government is going to frown upon that. You have to set that up properly. Also, are you going to, in the case of real estate, for example, take back a mortgage? Is this going to be vendor financed (transaction)?
If so, it's possible for you to perhaps think about setting up a capital gains reserve, which is not necessarily going to help you avoid the increase in the capital gains inclusion rate on or after June 25th, but it'll reduce your taxes, as those taxes are allocated in the year that you actually receive the proceeds for up to five years in most cases.
That's a good plan. In some cases, if you buy a replacement property, and these are very specific properties to usually real estate businesses, then it's possible to defer, recapture, and capital gains as well. Earning a capital gain in a non-registered fund, taking a look at where the assets are, understanding vendor financing, understanding some replacement property rules, those are the key things to talk to your accountant about. Also, don't forget, you can always earn your capital gains within your registered accounts. That might be a strategy for you is to think about where the capital gains should be earned now.
Should they be in non-registered portfolios or in registered portfolios? Some ideas there for you, Mark.
Mark: Thank you, Evelyn. Excellent advice and thoughts on that. do you have any broad concerns?
Evelyn: Absolutely. Lots of concerns. One of the first concerns is whether or not that $250,000 capital gains threshold is going to be indexed to inflation. That would be really important. This also makes a case for really managing accrued gains throughout one's lifetime with an even closer planning eye. A more proactive relationship with your financial advisor is so important. The taxpayer does ultimately have the ultimate choice, and that is the thing that is within your control: you can determine when you're going to dispose of your assets or transfer your assets and create a deemed disposition, for example, in all cases except one, and that is at the date of death.
That is an uncontrollable event. We do need to plan dispositions in advance of that. We need to understand where the assets are going to reside. We can plan to accrue gains and manage the taxable status of those accrued gains during our lifetime. Gifting to adult children is allowed, for example. Now, should this be done before or after June 25th, 2024? As we mentioned, selling assets over a reserve period is also another great coping strategy. There are things that you can do with regard to timing that can help you avoid ultimately a large capital gain over the $250,000 threshold.
Mark: Here's a part that makes my head hurt. When it comes to capital gains in private corporations, the rules are much more complex, aren't they?
Evelyn: Yes. Not only that, but the rules are unclear on many complex calculations that integrate the personal and corporate taxation systems. In fact, as we said off the top, (an example is) the availability of the small business deduction where there are large capital gains, and I'll try to explain that. In fact, there is also a potential for some double taxation if personal/corporate tax integration now has a greater imbalance to it. Some sales (or disposition of assets with) accrued gains may make sense before the deadline for these reasons, but this can have other consequences. That's the preamble.
Now, if we run through the numbers, the initial outcome on the sale of a taxable asset is that the corporation will pay about $100,000 more than they would have prior to June 25th, assuming a million-dollar gain. Remember that the corporation has no $250,000 threshold, no capital gains deduction within the corporation, and more expensive dividends to flow through to individual shareholders. When we look at more detailed numbers, we can see that when we distribute those dividends, corporate taxes rise and personal taxes rise, so that overall, again, we have close to a six-figure tax liability. Also, we see that the tax-free capital dividend drops from one-half to one-third.
Mark: I understand we're not done with the surprises yet.
Evelyn: No. Next year, there will be a clawback of the small business deduction, which provides a low tax rate to small business corporations. When passive investment income within those small business corporations, and that includes the taxable capital gain, when those passive investment income figures are over $50,000, the small business deduction is going to be reduced. Corporate taxes will rise from about 10% to sometimes 25% to 27%, depending on where you live, in the following year. You're going to have an increase in the taxes you pay on your operating profits in that case.
Now, looking down the line a bit further, there's more tax risk for families that transfer their businesses to family members, if specific criteria are not met, for example, the transfer of control, the transfer of shares, and the transfer of management in either a three-year or a 10-year period, which you can choose. Then capital gains treatment down the line is going to be reversed, and thousands of dollars will have to be repaid by those business owners (if rules aren’t met). Bottom line, many moving parts.
Mark: No kidding, and very interesting. I read a little bit on this piece, another option for companies is to sell to employees. Is that right?
Evelyn: Yes, there are new rules starting January 1st, 2024, for employers, small business owners who want to take advantage of new employee ownership trust rules. Business owners are now going to be able to sell their businesses to their employees and take a tax exemption for the first $10 million in capital gains realized on the sale of the business to an employee ownership trust. Now, initially, we're only going to be able to do this for three years, 2024, 2025, and 2026. We'll see what the government does after that. Some minimum taxes are going to apply in this case as well.
As you recall at the outset of our chat today, this is yet another capital gains exemption level that business owners are going to have to get their heads wrapped around.
Mark: Super interesting, Evelyn, but I'm sure there's some fine print to this one.
Evelyn: Employees who are interested in acquiring their employer's business will need to know that the shares of a professional corporation will not qualify here. Over 50% of the fair market value of assets must be used in an active business and the transferred shares must be exclusively owned by that individual who's acquiring them. The individual must be actively engaged in the business for a minimum of 24 months prior to the transfer and 90% or more of the beneficiaries of the Employee Ownership Trust must be resident here in Canada. The total exemption, no matter how many individuals are participating, cannot exceed that $10 million threshold and there are some disqualifying events as well. Again, fine print is important here, but with a $10 million exemption, well worth sitting down with your tax accountant, your financial advisor and your lawyer to sift through the details.
Mark: What's the bottom line for small business owner-managers then?
Evelyn: Look, taxes are going to be going up significantly and it's important to pay attention to your business valuation over the next little while to really assess what is the size of your capital gains are going to be, what are your capital gains taxes going to be. Remember there is a bright spot and that is after June 25th: the capital gains exemption is going to increase from just over a million dollars before June 25th to $1.25 million. That's about a $233,000 raise and depending on how many shareholders you have, for many people more of the actual gain is going to be tax-exempt when they sell their small business corporation or qualifying farm or fishing property.
Do it at the most advantageous time, but also make sure you understand how much of this is going to be ultimately tax-free. Going forward, set up your shareholdings properly as well. You may want to invite other shareholders into the fold as you anticipate the future of your business.
Mark: Are there any obvious bright spots to all of this?
Evelyn: There's one aside from that capital gains deduction level rising and that is donated securities will still have a zero capital gains inclusion rate as far as we can tell with the current information we have. You still get a 100% addition to your capital dividend account, which means you can extract larger tax-free capital dividends now and not pay any minimum tax. There are some advantages with regard to some of your life insurance policies as well and so those things should be reviewed before June 25th.
Mark: Let's just change course a little bit and speak to a few housing provisions.
Evelyn: Yes, housing has been a big focus for the government in this last budget and also in several statements beforehand. I do want to alert the audience who may have properties that are on some of the short-term rental platforms that there is an important rule that started January 1st, 2024. That is if you are not properly registered to have a short-term rental in your municipality or your city, then the tax consequence to you is that you'll have to report the rental income (as usual), but you're not going to be able to report and deduct any of your rental expenses.
It's really important to make sure you're on-side with the zoning, the licensing that's required in your municipality. When we define a short-term rental, we mean a residential property that's offered for rent for a period of less than 90 consecutive days. There are always fine print exceptions and details around some of those provisions. What it means is you're going to report income, no deductions to offset it, and your taxes are going to go up. Being compliant is really important, and you have to be compliant with your registration, your licensing, and your permits on December 31st, 2024.
Mark: Evelyn, thank you very much for this comprehensive update on the recent tax changes. It has been our pleasure to have you on for this edition of On the Money.
Evelyn: Thank you so much. It's always a pleasure, and I hope it's been helpful.
Mark: You've been listening to another edition of On the Money with Dynamic Funds. For more information on Dynamic and our complete lineup of actively managed funds, contact your financial advisor or visit our website, @dynamic.ca. Thanks for joining us.
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