The pandemic has shaken up small businesses and made filing taxes an even more complicated task for many owners. Chris Gandhu, a High Net Worth Planner with TD Wealth joins Kim Parlee to explain why this year is different and offer some thoughts on what business owners should consider before they file.
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[MUSIC PLAYING]
- It's getting near year end, and if you're a small business owner, you've got some decisions to make about your taxes. But this year, like everything else, is more complicated because of a pandemic. We're joined by Chris Gandhu. He's a high-net-worth planner with TD Wealth.
And Chris, great to have you with us. And thank you for helping people navigate through this. My understanding is, for small business owners, that they have to consider whether they're going to pay themselves a salary, get dividends, or some combination of both. So tell me about that and also what happens this year.
- Right. So Kim, you're right. That is the way typically you'd remunerate yourself is either by a salary or dividends. What may be perhaps surprising to you is that whether you choose a salary or a dividend, it really doesn't matter. It's, in fact, tax neutral at the end.
And the reason is, although dividends in your hands may be taxed at a lower tax rate, they're paid from after-tax earnings. Conversely, a salary may be taxed in your hands at a higher rate, as regular rate income, but it's a deduction to the company. So the company saves money up front. So in the end, it's all a wash.
Of course, that's theory. In practice, how long you choose to retain income in the company, your personal marginal tax rate. And in fact, even the provinces you live in can make a difference. But that's our starting point is that it's tax neutral. And then we sort of overlay with person circumstances and COVID, of course, would be a big one that may impact your remuneration planning.
- OK, so let's talk about the pandemic then and what that means for people. Because I understand what you're saying. In theory it's designed to keep everything neutral. But the reality is, is the pandemic has changed a lot.
- Yeah, I mean, for sure pandemic has had an effect. I mean, in my case, what I'm seeing are businesses that used to be quite profitable aren't that profitable this year. Well, if you happen to be in that circumstance, then perhaps taking a salary isn't the wisest decision for you this year. Like I just said, salary is a deduction that ends up saving the company some money, which is great for good times when there are actual taxable earnings to soak up that deduction. But if those taxable earnings aren't there, then perhaps a dividend is a good option for you this year and to minimize your personal tax.
But of course, we have to balance this, Kim, with all of the government COVID programs. When I look at SERV, or CRB, or the wage subsidy, they're all income tested. And if you're only earning certain types of dividend income, well, then you won't qualify for those programs. So there's a bit of a balancing act here between what may be the most tax optimal, versus what optimizes your access to these federal COVID programs.
- A lot to consider, and I mean, a lot of this is going to be, to your point, a bit backward looking in terms of what has happened. And if we could draw a line in the sand today, and say, OK, you're a business owner, what should you be thinking about for 2021 given the current circumstances?
- Right, so I mean, remuneration planning, as we just talked about, is important. But we live in Canada, where everybody's taxed on marginal tax rates. And a dollar saved truly is a dollar earned. And one way you can save a dollar is by sprinkling that income to perhaps other family members that are paying tax at a lower rate.
So whether you do that income splitting planning personally, or by using your corporation, then, of course, these taxation on split income rules did come into effect in 2017. But there are exceptions to those rules. So some of that planning still may be accessible to you. That's an option.
Another thing that's not uncommon is that a large business enterprise may have different divisions and different entities that run different businesses. And in Canada, if one entity has an income and one entity has a loss, the income and loss isn't automatically optimized. You, in fact, have to have to do some proactive planning to consolidate that. So that might be a planning option for business owners this year.
- What about, I mean, and this is a bit of rubbing your crystal ball to see what's going to happen. And I know that we have to be very careful when we do things like that. But we do know that the pandemic has changed some fiscal policy, some people believing we could see some changes in tax policy coming. Is there anything you're hearing or things that we should just be thinking about as these things get formed?
- Yeah, I mean, obviously, this is all speculation but there's a lot of talk about perhaps a wealth tax, maybe the GST rate may go up, and of course, talk about the capital gains inclusionary changing. So as you would know, Kim, presently capital gains are only included in income at a 50% tax rate. But historically, we've had them as high as 23 and 3/4% inclusion, so no reason we couldn't go there again.
And although I started off this interview by saying, there's really only two ways to remunerate yourself by a salary or a dividend, in some special circumstances, you're able to extract the money inside the corporation by using a preferred rate planning, so pulling it out at a capital gains tax rate. And if you feel with some conviction that that might be a tax policy that's changing in the near future, then I think that's some planning that you need to pay attention to today.
- You've turned me into a bit of a tax geek over the years, Chris, in terms of just understanding some of the ins and outs. But it sounds to me there's a lot here. This is not something we should be doing on the back of an envelope or at the kitchen table. This requires some serious planning.
- Yeah, absolutely. It does require planning. It is circumstance specific, so do talk to a professional.
- Chris, always a pleasure. Thanks so much.
- Thank you, Kim.
[MUSIC PLAYING]
- It's getting near year end, and if you're a small business owner, you've got some decisions to make about your taxes. But this year, like everything else, is more complicated because of a pandemic. We're joined by Chris Gandhu. He's a high-net-worth planner with TD Wealth.
And Chris, great to have you with us. And thank you for helping people navigate through this. My understanding is, for small business owners, that they have to consider whether they're going to pay themselves a salary, get dividends, or some combination of both. So tell me about that and also what happens this year.
- Right. So Kim, you're right. That is the way typically you'd remunerate yourself is either by a salary or dividends. What may be perhaps surprising to you is that whether you choose a salary or a dividend, it really doesn't matter. It's, in fact, tax neutral at the end.
And the reason is, although dividends in your hands may be taxed at a lower tax rate, they're paid from after-tax earnings. Conversely, a salary may be taxed in your hands at a higher rate, as regular rate income, but it's a deduction to the company. So the company saves money up front. So in the end, it's all a wash.
Of course, that's theory. In practice, how long you choose to retain income in the company, your personal marginal tax rate. And in fact, even the provinces you live in can make a difference. But that's our starting point is that it's tax neutral. And then we sort of overlay with person circumstances and COVID, of course, would be a big one that may impact your remuneration planning.
- OK, so let's talk about the pandemic then and what that means for people. Because I understand what you're saying. In theory it's designed to keep everything neutral. But the reality is, is the pandemic has changed a lot.
- Yeah, I mean, for sure pandemic has had an effect. I mean, in my case, what I'm seeing are businesses that used to be quite profitable aren't that profitable this year. Well, if you happen to be in that circumstance, then perhaps taking a salary isn't the wisest decision for you this year. Like I just said, salary is a deduction that ends up saving the company some money, which is great for good times when there are actual taxable earnings to soak up that deduction. But if those taxable earnings aren't there, then perhaps a dividend is a good option for you this year and to minimize your personal tax.
But of course, we have to balance this, Kim, with all of the government COVID programs. When I look at SERV, or CRB, or the wage subsidy, they're all income tested. And if you're only earning certain types of dividend income, well, then you won't qualify for those programs. So there's a bit of a balancing act here between what may be the most tax optimal, versus what optimizes your access to these federal COVID programs.
- A lot to consider, and I mean, a lot of this is going to be, to your point, a bit backward looking in terms of what has happened. And if we could draw a line in the sand today, and say, OK, you're a business owner, what should you be thinking about for 2021 given the current circumstances?
- Right, so I mean, remuneration planning, as we just talked about, is important. But we live in Canada, where everybody's taxed on marginal tax rates. And a dollar saved truly is a dollar earned. And one way you can save a dollar is by sprinkling that income to perhaps other family members that are paying tax at a lower rate.
So whether you do that income splitting planning personally, or by using your corporation, then, of course, these taxation on split income rules did come into effect in 2017. But there are exceptions to those rules. So some of that planning still may be accessible to you. That's an option.
Another thing that's not uncommon is that a large business enterprise may have different divisions and different entities that run different businesses. And in Canada, if one entity has an income and one entity has a loss, the income and loss isn't automatically optimized. You, in fact, have to have to do some proactive planning to consolidate that. So that might be a planning option for business owners this year.
- What about, I mean, and this is a bit of rubbing your crystal ball to see what's going to happen. And I know that we have to be very careful when we do things like that. But we do know that the pandemic has changed some fiscal policy, some people believing we could see some changes in tax policy coming. Is there anything you're hearing or things that we should just be thinking about as these things get formed?
- Yeah, I mean, obviously, this is all speculation but there's a lot of talk about perhaps a wealth tax, maybe the GST rate may go up, and of course, talk about the capital gains inclusionary changing. So as you would know, Kim, presently capital gains are only included in income at a 50% tax rate. But historically, we've had them as high as 23 and 3/4% inclusion, so no reason we couldn't go there again.
And although I started off this interview by saying, there's really only two ways to remunerate yourself by a salary or a dividend, in some special circumstances, you're able to extract the money inside the corporation by using a preferred rate planning, so pulling it out at a capital gains tax rate. And if you feel with some conviction that that might be a tax policy that's changing in the near future, then I think that's some planning that you need to pay attention to today.
- You've turned me into a bit of a tax geek over the years, Chris, in terms of just understanding some of the ins and outs. But it sounds to me there's a lot here. This is not something we should be doing on the back of an envelope or at the kitchen table. This requires some serious planning.
- Yeah, absolutely. It does require planning. It is circumstance specific, so do talk to a professional.
- Chris, always a pleasure. Thanks so much.
- Thank you, Kim.
[MUSIC PLAYING]