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Posted August 15, 2019 - The Link Between

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The 2018 Federal Budget introduced new rules that can reduce the amount of the small business deduction available for active income earned in a corporation. The small business deduction is reduced by $5 for every $1 of passive income a corporation earns over $50,000 and is completely eliminated if the corporation earns over $150,000.

Results summary

Your corporation's passive income is $60,000. There is an excess passive income of $10,000 beyond the $50,000 limit; this reduces your small business deduction by $50,000**. As a result, the tax paid on active income goes from $52,800 before the change to $57,600 after the change. The additional tax your corporation will pay on active income is $4,800.

Planning can be completed to maximize the small business deduction by reducing the corporation’s passive investments so that the passive income earned does not exceed the $50,000 limit (it is the prior year’s passive income that will determine the reduction to the small business limit) — for your corporation that would mean reallocating $100,000 of passive assets based on your assumed rate of return. This can be accomplished by investing in assets that generate capital gains rather than dividends and interest, repaying shareholder loans, distributing assets to shareholders by way of capital or taxable dividends, or by purchasing life insurance.

Note that there is still a deferral advantage to having income taxed in the corporation even if the small business deduction is lost, since the highest marginal personal rate is 48% in Alberta compared to the 27% active business income general tax rate.

There are many complexities to these rules, and every situation is unique. Your best option is to speak with your professional advisors to help determine the best solution for you and your corporation.

Assumptions

Tax rates used are accurate as of January 1, 2019: 11% for small business rate, 27% for general rate, and 50.7% for passive income rate.

* The rate of return is based on the taxable income earned in your corporation.

** Small business deduction limits available after the reduction are $450,000 federal and $450,000 provincial.

Disclaimer

This calculator is for illustrative purposes only. Readers should seek independent legal, tax, financial and accounting advice with regard to the views expressed on this site. Any numbers illustrated are provided as example and are to be used as estimates only.