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Reasons #1 On Why The Proposed Tax Changes Are Unfair

Posted By: Anonymous

By Nizam Shajani, CPA, CA, MBA, Partner

Passive Investments

The passive investment rules would affect the middle class and low-income business owners more than the higher income earners.  The idea behind taxing the passive investments within a small business was based on the premise that an individual who earns $50,000 at the highest tax bracket would have to pay 48% tax on that income – leaving only $26,000 available to invest.  This was compared to a small business owner who receives $50,000 and only pays 12.5% tax, leaving $43,750 to invest.  This was said by Finance Minister Bill Morneau to be inherently unfair.

Say both individuals receive a 5% return on their investment – the salaries employee would earn passive income of $1,300, pay tax of $624 and be left with $676.  The small business owner would earn $2,188 pay net (of RDTOH) tax at about 27% or $591 and have $1,597 remaining in the company.  This could be dividend out to the shareholder at a rate of 40.07% and result in a tax bill of $640 – to net the small business owner $957.  So, in this case the small business owner is $281 better off. 

The government has proposed changing the 27% tax rate on the passive income to make things equal for this such scenario.  However, this equalization is being proposed at the corporate level and before the remaining funds are taken out of the corporation and in the hands of the shareholder.  The proposal would result in about 69.1% tax on passive investments within a corporation and net the small business owner $405 after taking the remaining funds out as a dividend.  The small business owner would be $271 worse off than the employee and make saving via passive investments within a small business difficult.   

Also in considering this proposal – where the employee verses the business owner were in the middle-income tax bracket of $45,000 to $90,000 at a rate of 30.5% (rather than the 48% for high income earners), the employee would net $1,208 after tax in the passive investment whereas the small business owner would net just $536.  The small business owner would be $672 worse off.

The proposed changes now put small business owners at a disadvantage when compared to employees and puts middle income earners at a greater disadvantage than higher income earners when earning passive income within a small business. 

 

 Employee

 Small Business

Revenues

 $50,000

 $50,000

Tat rate

48.0%

12.5%

Tax paid

 $24,000

 $6,250

Available to invest

 $26,000

 $43,750

Return on investment

5.0%

5.0%

Return on investment

 $1,300

 $2,188

Tax rate

48.0%

69.1%

 

 $624

 $1,512

Net

 $676

 $676

Dividend out

 

 $676

Tax on dividend rate

 

40.07%

Tax

 

 $271

Net

 

 $405

 

 

 

This information is for discussion purposes only and should not be considered professional advice. There is no guarantee or warrant of information on this site and it should be noted that rules and laws change regularly. You should consult a professional before considering implementing or taking any action based on information on this site. Call our team for a consultation before taking any action.

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