Chapter 13 AP 13: Samantha Greene Purchase Of A Business

chapter 13 AP 13 Samantha Greenepurchase Of A Business Compen

Analyze the tax implications and optimal structuring for Samantha Greene's purchase of a business, considering whether she should operate as a proprietorship or incorporate. Evaluate the advantages of incorporation, including tax savings, cash flow, debt repayment potential, and retirement benefits. Incorporate the effects of personal and corporate tax rates, CPP deductions, dividends versus salary strategies, and applicable government credits. Offer recommendations on choosing the most tax-efficient option and strategic considerations for using additional cash to repay debt or invest in retirement plans.

Paper For Above instruction

Ownership and operation of a business significantly influence the tax liabilities, cash flow management, and long-term financial planning of entrepreneurs. When Samantha Greene considers purchasing a business, she faces a crucial decision: whether to operate as a sole proprietorship or to incorporate her business. This decision impacts her current tax liabilities, future retirement benefits, and options for income splitting and estate planning. An understanding of the relevant tax rules, rates, and strategic approaches is essential to optimize her financial outcomes and ensure compliance with tax legislation.

As a sole proprietor, Samantha's business income of $400,000 in 2020 would be taxed at her personal income tax rates, which are progressive and include both federal and provincial components. Personal federal tax rates range from 15% to higher marginal rates, while provincial rates vary. Her taxable income places her in a high marginal tax bracket, and this exposure results in significant tax liabilities. For instance, at combined federal and provincial rates averaging about 23%, her taxes could approach $92,000, reducing her net income. Additionally, as a sole proprietor, she must pay contributions to the Canada Pension Plan (CPP) at her personal rate, which for 2020 could amount to roughly $5,796, based on the maximum contribution limits. Her personal tax credits, including the basic personal amount (which is $12,298 in 2020), help reduce her taxable income but do little to offset the overall tax payable at high income levels.

Incorporation offers a strategic alternative that can lead to significant tax advantages. By forming a corporation, Samantha can split income between salary and dividends, allowing flexibility in tax planning. Corporate tax rates on active business income for 2020 are a flat 13% under the small business deduction (SBD), substantially lower than personal rates at high income levels. Assuming her corporation earns $400,000, corporate tax payable at 13% is approximately $52,000, leaving $348,000 in corporate after-tax income. She could then pay herself a salary (for RRSP contribution purposes and CPP benefits) or dividends (for tax efficiency, especially if corporate income taxes have been paid), both of which would be taxed at her personal rates but with potential for income splitting and dividend tax credits (DTC).

The decision to pay herself a salary of at least the year's maximum pensionable earnings (YMPE) ensures she qualifies for CPP retirement benefits. Since the 2020 YMPE is $57,400, she might pay a salary close to this to optimize her CPP benefits while minimizing personal tax liabilities related to higher salary amounts. The corporate income remaining after salary payments can be distributed as dividends, which are taxed at a lower effective rate due to DTCs. Moreover, dividends can be grossed up by 15% and taxed at her personal rate, but the accompanying dividend tax credits offset the gross-up effects, resulting in a lower overall tax compared to salary.

Tax strategies also include leveraging government credits to reduce tax liabilities. The basic personal amount (BPA) in 2020, which is $12,298, combined federal and provincial, applies to her taxable income, and other credits such as employment credits can further diminish taxes payable. Additionally, by incorporating, Samantha gains access to tax deferral opportunities: corporate retained earnings are taxed at 13%, which is lower than her personal top marginal rate, allowing her to retain earnings within the corporation and defer personal tax until funds are withdrawn.

However, the incorporation route necessitates additional compliance costs, such as corporate filings, separate accounting, and potential double taxation on dividends if not managed correctly. To mitigate this, she could implement income splitting with a family trust or family members holding shares, provided they meet the statutory work requirements and are over 18 (or 20 for TOSI rules application), and the income splitting is justified as reasonable under the "split income" rules. When implementing income splitting, she must consider the tax implications of the "Tax on Split Income" (TOSI) rules, which restrict the income that family members can receive if they do not meet the necessary criteria.

Recommendations favor incorporation given the evident tax advantages, especially in maximizing after-tax cash flow for debt repayment or investment in retirement savings. This approach allows a more strategic distribution of income, tax deferral, and the possibility of paying herself a salary that aligns with her retirement planning objectives, such as CPP benefits. It also provides flexibility in managing cash flows and implementing income splitting, increasing her overall wealth accumulation over time.

In conclusion, Samantha should incorporate her business to benefit from lower corporate tax rates, income splitting opportunities, and deferred personal taxation. She should pay herself a reasonable salary to qualify for CPP benefits and distribute remaining profits as dividends, utilizing dividend credits to minimize taxes. This strategy enhances her cash flow, reduces her effective tax rate, and provides long-term planning options for retirement and estate planning. Proper structuring and compliance with relevant rules, including TOSI and income splitting legislation, are essential to maximize these benefits and avoid potential pitfalls.

References

• Canada Revenue Agency. (2020). Small Business Deduction (SBD). Retrieved from https://www.canada.ca/en/revenue-agency/services/tax/businesses/topics/corporations/small-business-deductions.html
• Canada Revenue Agency. (2020). Dividend Tax Credits. Retrieved from https://www.canada.ca/en/revenue-agency/services/tax/businesses/topics/payments-income-withholding/t4-information-return/t4cs/dtc.html
• Deloitte Canada. (2020). Corporate Tax Rates and Planning. Deloitte Tax Publications.
• KPMG. (2021). Income Splitting Strategies and TOSI Rules. KPMG Insights.
• Canada Pension Plan Investment Board. (2019). CPP Benefits and Contributions. Retrieved from https://www.cppinvestmentboard.ca
• Thomson Reuters. (2020). Income Tax Act and Regulations. Thomson Reuters Practical Law.
• PwC. (2021). Tax Planning for Incorporation. PwC Tax Insights.
• Rogers, M. (2019). Tax Strategies for Small Business Owners. Canadian Tax Journal, 67(3), 519-542.
• Ontario Ministry of Finance. (2020). Personal Income Tax Rates. Government of Ontario Publications.
• Canada Revenue Agency. (2019). Clarified Rules on Income Splitting and TOSI. CRA Tax Bulletin.