Budget 2018 tax implications for a landlord and business owner

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Q: I operate a small construction company, mostly doing renovations for homeowners. Over the years, mostly to keep me and my main permanent employee busy during the slow season, I bought a number of triplexes that needed substantial repairs and renovations. At the advice of my accountant, I used the company funds and various mortgages to buy the buildings, and kept them in the company name. My various construction contracts now earn about $250,000 per year ( before I pay myself and my wife anything for our hard work), and the triplexes are generating about $75,000 per year in net income. What do the new tax rules announced in Budget 2018 mean for me?

A: In your situation, your accountant probably has you take out some of your business earnings as salary (or wages), and some of them as dividends. On the salaries, you and your spouse pay Canada Pension Plan contributions, but the contributions build up pensions from CPP. Your company then pays tax on its earnings after the other costs and your salaries.

You probably split the dividends between you and your spouse to take advantage of the lower income tax rates that apply at lower income levels. You receive credit for the tax the company pays, so that you and your wife pay in total what you would have paid if you had each earned that income directly (rather than through the company).

The current rules already say that the salary you pay your spouse has to be reasonable. Now, the dividends will also have to be reasonable, or your spouse will need to meet a new test, such as working at least 20 hours a week in the business.

By operating through the company, an active business, the company tax rate is quite low for corporate earnings (after salaries) up to $500,000 per year. That means that if you leave money in the company, you can defer the tax that has to be paid on that income. (You will have to pay the tax eventually, but paying later is better than paying earlier, since you get to use the money in the meantime.)

The federal government decided that they should rein in that advantage. The budget released on Feb. 27 proposes to limit the earnings that are eligible for the small business tax rate based on the amount of investment income a company earns. For every dollar of investment income over $50,000, the limit on income eligible for the small business tax rate is reduced by $5 — see the table to the right. Corporate earnings that are not eligible for the small business rate pay the regular corporate income tax rate.

You will not be negatively affected until your investments or your business generates more net income. However, people with more of either type of income than you have will see their tax deferral advantage reduced or eliminated. The impact can be reduced by taking more of the income as salary, but that in itself reduces or eliminates the advantage.

So far, most commentators say that the current proposal is better than the previous proposals. It is certainly simpler. You should seek out the advice of your accountant or tax professional.

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