I previously gave some illustrative examples of how crossing the new sliding active-passive income threshold into the higher general corporate tax rates could have an adverse impact on physicians and other high income professionals. Even a more moderate income physician who is a good saver.
It is important for those affected, to realize that they are affected, because they will need to learn the new active-passive income small business tax dance. At our previous-post-dance-party, we introduced the basic moves.
- First move: consider a salary to lower active income.
- Second move: consider an investment portfolio shuffle to minimize passive income in the CCPC while maintaining the desired investment asset mix.
A simplified example of a 60:40 equity:bonds portfolio shuffle was discussed as illustrated below.
That conceptually seems simple, but there are a number of potential practical difficulties to doing this if you anticipate a high savings rate that will overwhelm your registered tax-sheltered accounts or have high dividend-paying equities. Some professionals may have already built large portfolios in their CCPCs. With the sudden rule change, they now find themselves already in hostile uncharted tax territory.
If you wander off course into rougher tax waters despite some basic navigation, then prepare to be boarded…
Unfortunately, surviving the rougher tax waters will require more advanced planning, effort, and possibly some special tools.
Most of these come with some increased fees and/or risks. Getting a sense of how much of a negative impact (if any) that the rules will have on you and the risks/benefits of the tools to mitigate that impact is vital.
It is a prerequisite to making informed decisions on the degree of effort/expense/risk worth incurring to navigate around in pirate infested territory.
Firing at those after your loot isn’t without its hazards. Just ask this lady.
Let’s take a quick inventory of the potential weapons in our arsenal for repelling an unwanted attempt to tax grab our corporate booty…
#1 Target your stocks and ETFs with low or no dividend yield to your corporate account.
This one is the low-hanging fruit with no special risks or costs.
#2 Use swap-based ETFs in your corporate account.
Horizon is the only company in Canada who sells this product which passively tracks an index based on its total return (capital gains plus dividends/interest) and converts that to capital gains only. They have low effective fees (0.03%-0.5%), but carry some other risks. Disclosure: I use some of these products in my portfolio. Update: These were targeted in the 2019 Federal budget and changed to a more robust corporate class model.
#3 Use corporate class or T-series mutual funds in your corporate account.
Similar to swap-based passive ETFs, these actively managed products convert most income into capital gains. This comes at the cost of having significantly higher mutual fund level fees (1-1.5% plus advisor fee for high net worth clients to 2-3% retail). Generally, fees kill actively managed fund performance relative to their passive ETF competition. However, T-series mutual funds also allow for accessing money as “return of capital” which further delays triggering capital gains taxes during the draw-down phase of a plan. Like swap-based ETFs, there is some legislative risk (governments have a habit of changing the rules governing tax deferral investment structures to hobble or eliminate them).
#4 Target eligible dividend paying stocks towards a taxable account.
If you don’t have enough room in your corporate account and tax-sheltered accounts, but you need to put more equities somewhere. Target those with higher eligible dividend yields to a taxable account. They receive favourable tax treatment. This is particularly useful if the taxable account is solely attributable to a lower income spouse for tax purposes – who may even get an negative effective marginal tax rate on it.
The benefits of this approach need to be weighed against the opportunity cost of taking money out of the corporation and potentially losing that tax deferral advantage.
[2019 Update: It is also not universal. In most provinces, the tax rates have now risen so much that lower dividend-paying US or emerging market ETFs have less tax drag than the overall Canadian market. Even with the eligible dividend tax credit.]
#5 Use an Independent Pension Plan (IPP) to make up for insufficient RRSP room.
This is an insurance-type product. It is a potential way to make RRSP-like room over a shorter time frame. That can be done de novo, or by rolling over an existing RRSP into an IPP. The earliest you could open one is age forty and the earliest that you could punch out of work is age 55. It can allow pension-splitting at age 55. That is earlier than the age 65 rules for an RRSP. You need to pay a salary to access this tool. Plus, how much you are able to contribute initially and annually will depend on factors like your age and years of service (receiving a salary).
Generally, the benefit relative to RRSPs takes off around age 45 and for salaries >125K/yr. Not only does this approach shelter some passive income, but the cost is deductible against active business income. It would be very individual specific and requires an actuary initially to set-up (~$5K) plus a re-value every 3 years. There may be other management fees and restrictions depending on how the money is invested.
#6 Permanent (Whole or Universal) Life Insurance could be a way to hold a “fixed income-like” product within your corporation.
These products are usually structured to be “excluded life insurance” which means that they don’t count as passive income. Like all insurance, there are premiums paid. A portion of the premium covers the life insurance aspect (at a much higher cost than term-life). You can also pay larger amounts to have the excess invested.
You are stuck with their performance net of fees – for better or worse [spoiler – it is often worse]. The main gains in performance are later in life and the overall return is lower than investing in equities. Of course, the risk is also lower. If used, it should be a long-term relationship with fixed income-like return expectations.
You could borrow against the cash value of your policy before death and/or there are potential estate planning advantages since the pay-out at death is tax-free.
Weighing the pros/cons of whether to use this one is important. White Coat Investor has done the most balanced description of when to consider permanent life insurance that I have found so far. With our new tax considerations, there may be some renewed interest in Canada. You would definitely want someone other than the insurance salesperson to do that with you, since these products are attached to highly motivating commissions. You also need to be careful to structure the policy properly. An expert & impartial financial planner would be strongly advised for someone considering this.
#7 If you are a double professional household, you might re-examine your corporate structure.
I know a number of double doctor families. Some of have one shared CCPC. Others have two separate ones. It previously didn’t matter too much for most. However, with the threshold now potentially shrinking, it may be more important to have two CCPCs with access to two small business deduction limits.
For that to work, the ownership structure and control is important. Because they are married, both CCPCs would be “related”. If there is cross-ownership of 25% or more, then they would also be “associated” and need to share their SBD. You can read more about associated versus related CCPCs, but it may cause vertigo and is best done close to the ship’s railing.
For those using real estate investments to build income, the corporate structure for holding those real estate ventures in relation to your CCPC is important and well described by Dr. Networth.
#8 Work less. Spend less if you need to.
One unintended consequence of taxing productivity is that it can dis-incentivize work. Reflect on your work-life balance and consider working less. With progessive marginal tax rates and this progressive tax on professional corporations, you earn less per hour of work if you work more. If you spend everything that you make, then you would need to re-consider your spending also. What your are spending for either is your time, and your Time-Money Exchange Rate worsens as you earn and spend more.
There will not be a one-size-fits-all strategy
If you are a DIY investor/planner, then you definitely want to pay attention and learn. Most busy professionals probably won’t take on that effort (even though it pays well if done properly) or responsibility (being able to blame someone else if things don’t go well is an underappreciated perk of using an advisor;)). For most high-income professionals, finding a good financial planner and tax planner will be vital to help them navigate.
Even for those using professional planners, working knowledge of the main strategies and where they may fit into a comprehensive plan will help them be educated clients. That is especially vital when dealing with strategies or products that may have motivating commissions/incentives associated with using them.
Hopefully, you will join me in learning more about these strategies and tools with the upcoming blog posts.
Terrific site! Thank you. So many details are relevant to me. I’m a DIY investor. Dual physician family. On recommendation of accountant switched from 2 separate corps to form a new combined corp (this was immediately prior to introduction of proposed changes.) I’m using some horizons swap products. Still much to learn regarding the impact and options of new tax changes. I’ve been a “good saver” and believe that accumulated assets prior to tax changes (old corp) should be exempted( I hope). We are 50ish and need to structure our assets in new corp considering info you have provided. I need to determine whether the new rules will have an impact on individuals whose work horizon may be another decade. ie. assuming old assets are grandfathered will we accumulate enough passive income to be affected and , if so, what can we do to maximize our retirement assets. I’ve just discovered your site and appreciate the education you provide.
Thanks and great to have you stop by! I am learning a tonne researching for this site and liaising with other docs and some of the finance professionals. There is huge variation in how people have been set up and the advice they have been given – just like medical conditions! Unfortunately, I think the grandfathering of old assets piece is unlikely unless the government does another 180. We’ll have to see how this progresses through parliament. Good news is that we do have some time to figure it out and there are plenty of options to work with.
excellent summary of the strategies, LD! the only I know of to add is RCA, 50% of which must be held in cash position.
Like you said, different strategies apply to different situations. Ultimately, corp saving is a deferral and there is another layer of tax upon withdrawal. Unfortunately, I don’t think there are many withdrawal strategies to avoid the punitive top bracket.
Thanks BC Doc. You always bring some great additions to the conversation! I considered adding in an Retirement Compensation Arrangment (RCA), but I still don’t have a full grasp on them and they seem like you would need HUGE amounts of excess assets to use them well. Capital Surplus Stripping was another option I considered putting in the article, but it again seems most useful if you have huge assets that you need to move and it is at a cost of ~$30K in fees. My preliminary thoughts are that most people will probably be able to get away without these big guns – but I am honestly still wrapping my head around them! Will have to add these to my homework list!
Once again, another great summary LD!
For the Capital Surplus Stripping, 2 of my colleagues are using this option this year before they close this loophole. Their tax-lawyer is charging $10k for set-up. The $30k sounds a bit expensive. Taking corp $$$ out at 25% tax rate and then invest outside of corp may make sense for some, considering the $50k passive income limit in the corp.
My accountant mentioned this option for me as well. We are doing some calculations to see if it makes sense for me or not. I’ll pass on any info that I can gather from him.
Hmm. Really. That sounds much more attractive. Does that include any extra accounting fees? Thanks for passing that along. Probably deserves a relook!
I would be curious to know how much total fees (accounting & legal) are too.
I know of someone who recently used this strategy and his total cost for the entire process was about $20K. I asked my own accountant and he said it would be about $60K which sounds very excessive to me. He said the fees also include utilizing the total life time capital gain exemption which is about $800K right now. Still seems to high to me.
It seems like out of the mobster movies where you need to “know a guy…”
I have decided against the IPP and will hold off on any other strategies for now. It seems every time we counter with a strategy and pay for it, the benefits become minimized or reversed over time.
My husband is finally beginning to realize it may be time to slow down. So it’s become a good thing after all.
Ha! You’ve obviously seen this movie before 🙂 It does seem like a game of cat and mouse.
Slowing down (or not slowing down, but redirecting energy elsewhere) when you have good financial health is an elegant solution to progressive taxation that is hard to legislate against.
Hurray!,good one LD. Am I correct that eligible dividends in the corp are efficient as long as you’re taking enough money out with non eligible dividends? I began filling the ccpc with CAN equity and gics and the rest is outside in rrsp Tfsa and my taxable account. I’ve just filled the 50% allocation of CAN equity and FI of our total portfolio (CCPC) and am now looking to start adding foreign equity through the horizon swaps. HXS HXT and then once rates have climbed enough for GICS to become redundant then maybe some HBB.
One idea I’ve been flirting with is to move towards an all equity portfolio. I’ve kept 20-25% in bonds for some time but my wife’s DB pension has been building. With a more secure undrlying income base and the increased tax efficiency of equity over FI this could be a good choice.
Yep. You are correct. I am just building a calculator portfolio building tool that accounts for the taxes etfs based on income type, account type and accounts for foreign withholding taxes and whether you trigger your RDTOH from the corp, and personal tax rate if a personal taxable account . It also displays asset allocation and account type. Almost done. Want to be a Beta tester?
Sure that’d be fun.
Sending. It is an Excel-file. It won’t work on tablets or phones (too complex). Have fun and let me know how it goes.
Would you be able to send me one of the beta-testing Excel files too?
Absolutely! The more the merrier!
Me me me! Still trying to grasp RDTOH (your Klingon article is the funniest I’ve yet seen, and I will share it), but on a practical level, I need to calculate what’s going to happen to our portfolio with all these changes. Thank you in advance!
I will send the basic calculator along. I am just cleaning up another one that models over an up to 35 year period. I am toying between calling it the Incorporated Professionals Retirement Saving & Income calculator or simply “The Beast”.
All equity portfolio is a great idea inside the corp if you can stomach a 20-30% correction. I have about 25% fixed income (FI) in my corp and almost all FI in our RRSP including a spousal RRSP. TFSA is all equity and non registered is about 60% equity. Asset mix is about 70% equity overall.
I’m more comfortable with a bit of boring FI inside the corp. I don’t watch bnn as much and only check the markets a few times a week and find I sleep a little better.
I will be losing some or most of the small business deduction next year. I am looking at swap based etf’s (thank you LD for recommending) for the equity I manage myself. I will never buy universal life. Term insurance and disability is all I hold.
IPP seems like another fee grab.
Plan is to slow down when passive income threshold is breached and then just take salary.
Thanks sharing your plan! Sounds like you have given it alot of thought and have been weighing the options for your situation. Awesome!
I plan to have a very similar equity / FI mix to BBATW. Only diff is I will hold VGRO in my TFSA since I then I do not even need to rebalance until I switch in later years to all equity.
Most of my assets are in VTI for US equity, XIC for Canadian equity, and XEC and XEF for international and emerging markets.
I hold some of my Canadian equity in the Horizons total return swap ETF. However, I am leery of holding too much in the swap funds. As you have pointed out, this structure is ripe for legislative attack, especially if too many people start using the sway funds to minimize passive income (just like income trusts were legislated away once too many companies started to adopt that structure). The risk would be that there would be a sudden, unplanned capital gain if the tax law around swap based ETFs changes, and it would be a double whammy if the government also raised the capital gains inclusion rate from 50% to 75% at the same time.
I agree with Dr. MB that the government seems to be encouraging mid-late career physicians to slow down and work less.
I feel the same and use a similar strategy. You are going to love the upcoming swap based etf posts and the calculator that compares them accounting for fees and taxes. Some give you and excellent “risk premium” and some don’t. I too worry about the capital gains inclusion rate. It has been whispered about for the last two budgets. The favourable taxation of eligible dividends is in keeping with tax integration, but capital gains could be seen as more arbitrary making them vulnerable to the current narrative. It was not that long ago that the inclusion rate was higher.
Any thoughts on private equity? I did sign up for the MD platinum private equity pool. Deadline is April 30th. Min 50K US. Ten year investment managed by Blackrock. Returns would be return of capital and then hopefully capital gains. Could help limit some passive income short term, I believe.
Great question! I thought about the MD Platinum private equity pool too. As long as it isn’t dominant, having some “alternative” investments helps with diversification. I was a bit leary about locking up money for 10 years and not controlling how it is distributed back to me with the new rules and then I honestly forgot about it! Return of capital is attractive. Do you know when they (hopefully) distribute capital gains down the road if there will be any control to allow you to spread them out rather than take in a single year?
I’m not sure. I do like the fact that it’s professionally managed by a reputable firm (the vetting has already been done). Unless one invests a big chunk of capital (I went for the minimum) the gains (fingers crossed) shouldn’t be too hard to handle. I agree that it shouldn’t be a huge part of your equity exposure.
If one is close to full retirement (next 5 years), than the loss of the small business deduction may not be a big deal.
I agree. I kind of wish I hadn’t missed the deadline, but “Oh Well”. I imagine if there was good up-take that another opportunity will come along for me to consider.
What was the management fee structure? I forgot to ask my MD advisor about that. Thanks.
I talked with the advisor and didn’t think it was that good of an option. Their target return was 1-2% above index, non guaranteed of course. Return seems low given the lock up period.
I was more turned off by the fees. Essentially, you pay md and black rock. On top of regular mer, you also pay for performance. It seems to be a good investment for md and black rock. 😉
Agree. I do however prefer this over trying to find the perfect real estate joint venture partner, worry about leaking roofs, deadbeat tenants and a real estate correction that could cause one to lose more than their original investment.
I Believe they get a performance bonus if returns are above a certain percent but I don’t recall the exact terms.
Unfortunately fees and taxes matter so much when investing as good ole Dr. LD is showing us.
I recently came across your blog and have been devouring it for the past few days. I will soon start getting my head into the calculators. You have devoted a lot of time which I greatly appreciate.
I didn’t know where to post my question so hope this suitable as I did not see a Q&A section.
I am trying to crystallize capital gains using an ETF by selling and buying back the same day. However the trade volume will be a large percentage of the daily volume and I would also like to minimize losses due to the bid ask spread. I understand ETFs can be created and cancelled so they somewhat different than stock trades. Would you have any tips on executing this trade to minimize costs?
Hi NaDH. Thanks for stopping by and I hope you find things useful. It has been useful for me working through these issues. I am doc, not trader, so my advice should be taken in that context. When I did trade in smaller volume stocks for a brief time (unwise of me), I encountered the liquidity risk problem that you are describing. The only thing I can think of is to make it a limit order with a price limit not much below the current price. That may mitigate some of the drop, but it could also result in you not fully executing the order. The other option would be to sell in smaller aliquots with a limit order. That would be more brokerage fees that may eat away a bit and likely have the same problems I suspect. Again, I would say that I am an amateur in the area. If anyone has other thoughts, feel free to post them:)
I did a bit more digging and it seems the spread (and likely a bit more) will be the price to pay for my trade.
Dan Bortolotti also suggests placing the buy above the ask or sell below the bid. He provides some further insight in the comments section here:
ETF providers say you can call them to arrange a “block trade” if it’s a very large order, but we’re talking about seven figures: an advisor, for example, might do this when buying for several clients at the same time.
When I spoke about the ETF creating new shares, this is again only relevant for very large cash inflows. New units are typically created in blocks of 50,000.
Vanguard also gives a good explanation, especially wrt timing on foreign ETFs, and suggests going through a brokerage’s block trading desk for large trades. I am not sure if discount brokerages offer this service.
Thanks for posting this info.
Another great post. I have substantially reduced my work hours and therefore my billings. For the last 7 years, I and my spouse have only taken dividends from the corp. Avoided employer health tax, CPP payments, etc but “lost” RRSP room. With the new rules we both plan to take salary from the corp (spouse is actively employed in the practice). This will re-establish RRSP room again and will reduce active business income to< 50K.
Wondering if there are any thought here about realizing cap gains to build up the capital dividend account so it can be drained out later without taxes owing. This does reduce the advantage of tax deferral inside a corp. but since the taxes were only deferred, not avoided, the will have to be paid eventually.
As I prepare to fully retire from my paid job and transition into an unpaid volunteer job, I’m looking at a strategy of winding down the corp over the next 10 to 15 years. Will end up paying taxes a bit sooner than we need to but will simplify things going forward and esp. for the estate. Any and all thoughts appreciated.
Hi Crazycardio. Great question. I have honestly tossed this one around a bit. I recently did realize some capital gains while re-jigging my portfolio in light of the new passive income rules.
My accountant and I discussed letting my CDA sit for retirement income planning vs paying it out now. His advice (which I agree with) was to empty it now. We are using that money to top up our RRSPs/TFSAs again in the new year and will simply draw less from the corp next year. So, a wash in terms of the leaving money in the corp for us.
The downsides of selling and letting it sit are that if you have losses in the future, they can then draw down your CDA. Even to negative, at which point you’d have to make it positive before accessing. There is also some loss of tax deferral by realizing capital gains (although minimal ~10% if you pay out dividends to live on and your corp gets the RDTOH). The other downside of realizing capital gains early is if it hits the passive income threshold and bumps your active income corp tax rate. Realizing them in retirement won’t matter since you wouldn’t have active income at that time anyway.
The potential upside of realizing capital gains early is if the inclusion rate rises in the near future from 50%. It has been higher in the past (66-75% I think) and there has been talk of going back to that, but only speculation.
No easy answer, but those are my thoughts.
Reading this post almost 1 year later, but it’s still so useful! Thank you for the post.
I have one question. For #1 Target your stocks and ETFs with low or no dividend yield to your corporate account, I 100% agree with this point. I’ve been trying to find out which ETFs have low/no dividend yields. I’m specifically interested in VGRO, VCN, XEI, etc. If you have any good reference, please link/send them away!
Thanks again! And happy new year!
There are very few. The only ETFs really are the Horizon Corporate Class ETFs. I wrote about them just this past month. The have a structure that should hopefully pay out minimal or no dividends (but make capital gains instead). HXT, HBB, HXDM, and HXS are examples.
I’ve been reading your posts and all I have to say is wow you are awesome! Thank you so much for sharing your knowledge.
For #1 Target your stocks and ETFs with low or no dividend yield to your corporate account, I was thinking of buying tech stocks which pay no dividends. There are way more US tech stocks to choose from. What are your thoughts about purchasing tech stocks, such as Google, Microsoft, and Amazon in a US account, as a strategy to minimize dividend yield in the corporate account? I apologize if this question has already been answered.
Thanks Rockhopper. Yes, that is a good approach. There are a couple of twists though.
First, I would say that it is most important to pick the right asset allocation and diversification for you. Dividend yield is a secondary consideration.
Next, is asset location. Two approaches depending on the situation.
a) If unlikely to go over the passive income limits (or plan to cut active work/income when the portfolio is that large) and you pay out enough dividends on top of your salary to cover your living expenses, then Canadian eligible dividends can be very tax efficient in a corp.
b) If likely to be affected by the passive income rules and/or you don’t spend enough that you are taking lots of dividends out of the corp, then low/no dividend stocks or ETFs are more tax efficient. This is typically a big earner/saver low spender. We are in this boat. What I have done is split my US exposure into IJS for small cap value and for large cap value (HULC.TO or Brk.B), and large cap growth (like the Googles Amazon’s etc) – either HXQ.TO (no dividend and in Canadian-listed) or QQQ (US-listed Nasdaq 100 with dividend <1%). I find that ETFs are easier to have enough diversification. If a really large account, then stocks to pseudo-index is possible, but a lot of work and not as diversified. A couple of comments what I use: HULC.TO is thinnly traded, so that could be and issue. Brk.B is a stock not an ETF, but pretty diversified holdings. HXQ.TO and HULC.TO are Horizon's corp class - so there is a risk that they could pay out some kind of dividend in an extreme situation, but I think that is unlikely to be a major issue. I wrote about the corp class ETFs on the blog elsewhere.
None of this is specific investing advice (I am not qualified for that), but it is how I approach it. Good luck!
I’m mostly an ETF investor with some dividend stocks to compliment. Great point about diversification. Thanks for letting me know about the Horizon small and large-cap ETFs. I’ll check them out. We haven’t hit the SBD limit yet but wanted to plan ahead and start buying some stocks that do not pay out a dividend. Is it better to max out on the SBD limit first then start buying non-dividend paying stocks or buy both in parallel? There’s probably no single best answer but just wanted to know the advantages and disadvantages to consider.
Hey Rockhopper. That is a really interesting question about when to start. I looked at this (unpublished to date). The most efficient strategy is to look at when you plan to retire or cut back substantially and also try to predict when you’ll be affected by the SBD limits based on your contribution rate, rate of return, and passive income level. That is really complicated and also involves significant guessing about rates of return. You’d try to adapt to hit the limit just as you retire.
A more simple approach. Use my Corp vs RRSP vs TFSA calculator to get an idea of when you’d hit the passive income limit based on your current income/spend/asset allocation. If it is much younger than when you plan to cut back, then I’d minimize my non-Canadian income in the corp. Another ETF to mention is HBB.TO which is the bonds corp class ETF. If I need to hold bonds, using that in the corp is an interesting approach. I wrote about it a while back as a comparison to ZDB.TO (discount bonds). I am now thinking, it may actually also be a good way to save space in the RRSP by using some HBB in the corp instead of bonds in the RRSP. Both are tax-deferred accounts, so you are sharing the crappy returns of bonds with the government in exchange for damping pre-tax volatility and behavioural risk. Dividends from US-listed ETFs are 100% efficient in an RRSP (why I hold my IJS there).
Your comment got me thinking. are there Horizons ETFs that do not pay out dividends and would mimic the 3-4 ETF Couch Potato strategy. Personally, I have been using XAW/VCN/ZDB in the corporate account so I’m thinking if there is something similar offered by Horizons. I’ll have to check out Horizons website. You did mention about HBB.TO that would cover the bond component.
Hey Rockhopper. Yes, Horizon has some equivalents. HXCN and VCN are very similar. HBB is very similar to ZDB. For XAW, they have HULC.TO which is US large cap and HXDM.TO which is non-NA developed large cap. HULC.TO and HXDM.TO aren’t quite as diversified as XAW because XAW will also have some more small cap exposure.
I just found this very informative article.
Hi Rockhopper. It is a good article. Here is the analysis I wrote about the corporate class swap ETFs as well. I took a decently deep dive.