What to Know About The Capital Gains Changes
Capital Gains Inclusion Rate Changes – June 25th 2024
As you are likely aware, since June 25th 2024 there were changes made to the capital gains inclusion rate. This is obviously going to result in different ways of treating potential capital gains with an impact on the bottom line. In this post I will provide some examples of how the changes may affect certain scenarios as well as some methods to try and limit the effect of the changes.
Review of the Change
Let me start by taking a second to recap what the changes are. Prior to June 25th capital gains were taxed at a 50% inclusion rate across the board. As of June 25th there is now a more complicated calculation and set of circumstances around the inclusion rate.
The inclusion rate is still 50% on any personal gains to a maximum of $250,000 per year. If you realize more than $250,000 of gains personally in any given year the amount that is higher will be taxed at a 66.67% inclusion rate. The 66.67% inclusion rate applies immediately on the first $1 of capital gains within a corporation. In a corresponding move the Lifetime Capital Gains Exemption was increased from $1,016,836 to $1,250,000
Examples
Example 1. Bob owns a cottage that he paid $250,000 for 25 years ago. Today it is worth $1,000,000. That is a capital gain of $750,000. $250,000 of that will be included at 50% and the remaining $500,000 will be included at 66.67%.
Let’s assume Bob is in the highest combined marginal tax rate in Saskatchewan when he sells the cottage. This is 47.5%. His tax on the sale would be as follows:
As you can see, because of the changes Bob will be on the hook for an additional $39,591.25.
Next let’s compare how these changes could affect a corporation.
Example 2. Jane owns a cleaning company and has established a reliable business she is looking to sell. She has incorporated the business and owns 100% of the shares personally. They are also Qualified Small Business Corporation shares which make her eligible to use the Lifetime Capital Gains Exemption. Her Adjusted Cost Basis is nil and her sale amount is $5,000,000.
Planning Complications
The examples above are relatively straight forward and meant to show you how the changes affect the bottom line. There is a variety of things that can make matters more complicated, some of which include:
- Passing on a family run business or property to children
- Involvement of holding companies or trusts
- Death
As I have illustrated in the examples above, capital gains are still a favorable form of taxation. However, the taxes associated can still equal large dollar values and shouldn’t be left without a plan on how to handle them.
In the case of the cottage Bob may wish for his children to own it one day. If Bob were to pass away his estate could have $217,716.25 in taxes owing because it would be considered a deemed disposition. If Bob did no planning for this his children would potentially need to qualify for a loan themselves to keep the cottage in the family or simply sell it so that taxes can be paid.
What Can Be Done?
Although nothing will remove the taxes associated with capital gains there are ways to plan for them and mitigate the impact.
1) Utilize Capital Gains Reserve
Capital gains reserve is a way to defer gains to future years. For instance, if Jane was going to sell her company for $5,000,000, she could elect to take the proceeds over the next 5 years with $1,000,000 paid to her each year. This would allow her to utilize the $250,000 that is taxed at 50% inclusion rate 5 times instead of only once, saving her just under $80,000.
2) Use Life Insurance as an Asset
Life insurance is sometimes overlooked when it comes to what is useful during estate planning. The capital gains inclusion rate changes have only made life insurance as a planning tool a more enticing option. Some of the pros of using life insurance are, that it creates a cost effective way to cover tax liabilities on death, provides liquidity relatively quickly, plans can be structured with some flexibility and when held in a corporation potentially 100% can be paid out tax free from the Capital Dividend Account.
3) Estate Freeze or Slow Dispersal
It’s never a bad thing to have a plan in place earlier rather than later, although this is often difficult to implement successfully since plans can change. Using tools like an estate freeze or slowly realizing capital gains in batches is another way to try and combat capital gains taxes. An estate freeze allows you to keep control of your company, locks in your tax liability and passes any future growth liability onto your successor. If you have the ability to control when and how much capital gain you realize you could always start slowly realizing some gains each year prior to a total selloff. This would allow you to take advantage of the first $250,000 at 50% inclusion multiple times.
Ultimately planning for capital gains taxes is a fairly complicated process and nothing should be done without proper tax and legal advice from professionals.
If you would like to work together on planning for potential capital gains, send me a message by clicking the link below.