In light of proposed tax changes announced by Finance Minister Bill Morneau, many financial advisors are doubtlessly revisiting the drawing board, recalibrating their clients’ plans to account for the sudden development. Before the changes kick in next year, advisors and clients can consider some tactics to mitigate any potential financial damage.
“One of the changes relates to the elimination of the capital dividend account (CDA) from passive investment income,” said TriDelta Financial President Ted RechtShaffen in a column published by the Financial Post
. He explained that the CDA gains a dollar for each dollar of taxable capital gains generated in a corporation; someone could draw money from the corporation equal to the amount in their CDA balance, with no additional tax.
Those who have a corporate investment account, he said, may want to sell their gains this year, boost the CDA account, and file to draw down the account before Dec. 31. “Normally you might want to hold on and defer capital gains, but with the new rules … your effective tax rate will be much lower on capital gains in 2017 than in 2018.”
Business owners with adult children have another option. Assuming the children’s income isn’t that high, their average tax rate this year will be much lower than the marginal tax rate that the business-owning parent will likely pay for drawing out funds in 2018. Therefore, paying a lot of dividends to the children (as well as any other shareholders who are in a lower tax bracket) this year is something worth considering.
A third course of action is to crystallize capital-gains exemptions for shareholders to whom the exemptions might not apply in the future. “There are ways that [a client’s] accountant can trigger the gain this year using different share classes in the operating company or with rolling shares to a holding company,” RechtStaffen said. “There may be a risk of prepaying some alternative minimum tax, but this would likely be worthwhile assuming there are large capital gains for the company.”
Finally, he suggested using life-insurance policies more extensively in corporations as an alternative to drawing funds out. “Advanced strategies can be used to tax shelter passive investments by shifting some of those passive investments into universal life insurance policies,” he said.
Younger business owners will want to employ life-insurance strategies that let them withdraw funds efficiently from their corporations during their lifetime. Older business owners, meanwhile, can experience significant tax savings on estate planning, as well as better after-tax rates of return on investment compared to many traditional investments.
For more of Wealth Professional's latest industry news, click here.
Why new tax changes will hit one group hardest
Business owning clients need their advisors more than ever