What is Passive Income Tax and Are You Paying Too Much?

The Small Business Deduction, “reduces the corporate income tax that a corporation would otherwise have to pay in a taxation year throughout which it was a Canadian-controlled private corporation (CCPC)”.

As the Government of Canada continues to outline,

“A corporation’s SBD for a taxation year is generally calculated by multiplying its SBD rate by the lesser of its:

  • Income for the year from an active business carried on in Canada, excluding certain income and exceeding certain losses,
  • Taxable income for the year; and
  • Business limit for the year.”

From 2009 on, the business limit has been $500,000. But with the changes we saw in 2019, new rules for passive investment income have affected how much of a CCPC’s active business income is eligible for the SBD.

Consider this, now for every passive dollar earned above $50,000 a year, you lose $5 of your small business deduction.

That’s the equivalent to paying an additional 80% tax. Yes – you read that right, 80%!

It’s no wonder so many business owners have a newfound focus on saving on passive income tax. The good news is we’ve got four helpful tips for doing just that.

Decrease Taxes on Passively Generated Income

Here are four tips to help decrease taxes on passively generated income.

Utilize your capital gains investments

Capital gains investments, including stocks, real estate, and corporate class mutual funds, are taxed at a much more favorable rate than dividend or interest income.

Read about four other ways to use your corporation and save taxes in this post.

Invest in corporate class funds

Corporate class funds (those held inside a mutual fund corporation) are an incredibly tax-efficient option that also happens to be one of the most common choices for building your investment portfolio.

Look into corporately owned overfunded life insurance

In many cases, paying more into a life insurance policy than what it requires helps you accumulate cash and save on passive income tax. Done strategically, this comes with several benefits, including asset protection, tax-free withdrawals, flexible investment options, and more.

While we’re on the subject, read more about the two primary situations when life insurance is a powerful tax-efficient investment tool by clicking here.

Utilize your capital dividend account and check to see if you have a balance

A capital dividend account is a notional account- this means you don’t see it unless it has a balance. It allows for tax-free flow-through of life insurance and capital gains.

If you have not yet to create a capital dividend account for your corporation, you are missing out on one of the best-kept secrets of successful business owners and entrepreneurs.

(Link to video on why you should have a CDA)

Are You Paying Too Much Passive Income Tax?

These passive income rules have meant more challenges and confusion for corporations over the past few years. But with the right help and strategy, effectively navigating these rules and saving money on passive income tax simultaneously is possible.

If you’re excited about your financial future but don’t have a plan, getting in touch with your financial advisor is the first step in one of the most important decisions you will make for your business.

*The comments contained herein are a general discussion of certain issues intended as general
information only and should not be relied upon as tax or legal advice. Please obtain independent
professional advice, in the context of your particular circumstances.