Tax Fairness in Canada

[TimG]

I know cuz I'm a tax accountant who uses RRSP's, TFSA's and my corporation to save my money.

Yeah, I understand that. But every angle I have discussed with my accountant comes with risks/assumptions/downsides. So for me, I just take the money out and pay the taxes due.

[msj]

Yeah, I understand that. But every angle I have discussed with my accountant comes with risks/assumptions/downsides. So for me, I just take the money out and pay the taxes due.

You're problem is that you aren't making enough money (or spending too much or a combination of both) to make it worthwhile.

I'm lucky because I'm an accountant so I don't have to pay thousands each year for T1/T2/T4/T5 and financial statement preparation which pushes the math further in my favour.

[msj]

Money left in the corporation cannot be used to live on. If it is invested the rate goes up to the regular corporate rate. If you pay salary for living expenses you pay normal tax. If you pay dividends you pay corporate tax on the dividends and but get a reduced credit which leaves you with the same after tax if you paid income (except you don't have to pay CPP).http://www.thebluntbeancounter.com/2011/12/should-your-investment-income-be-earned.html

The thing that you are missing is that you can report certain investment income as part of regular earnings.

No, dividends should be reported on schedule 3 and will be subject to Part IV tax but who cares if you are paying the spouse a dividend anyway (since Part IV tax is refundable on this basis).

Then throw in tax efficient investments that defer income for years/decades and one can set up a nice little corporate holding pension fund for themselves and then receive dividend income when they retire and eventually wind the company down.

Had a woman come in the other day with the remnants of her company with $150,000 left in it.

She could take the $150,000 out all at once and pay $36,000 in total tax.

Or spread it out over 3 years for total taxes of ~$14,000.

Or do it over 5 years for total taxes of ~$6,000.

That's her situation.

That's lots of people's situations when they have successfully used a CCPC.

The key is to have a plan that considers OAS clawback and RRIF rules and most people are better off.

My savings practice is this: max out the TFSA, max out my RRSP, leave the rest in the company.

For me it is better to do this than pull out money at 45% tax rate and then invest the remaining amount in a non registered account.

Even if the company is paying tax at 45% on the investment income within the company (and it's not really in the long run thanks to RDTOH) you are better off since you are leaving the money in the company and not reducing the principal by 45% by paying personal income tax on it.

Edited September 11, 2015 by msj

[-1=e^ipi]

With respect to 'fairness', do you think a tax system should satisfy the following 'fairness' principle?:

Suppose you have two otherwise identical fishermen that both earn $100000 over 2 years. One earns $50000 each year and the second earns $40000 in the first year and $60000 in the second year (+ this economy has no interest rates or inflation). Should the two fishermen pay the same amount in taxes?

If your answer is yes, then how about we generalize the numbers:

Suppose you have two otherwise identical fishermen that both earn 2X over 2 years. One earns X each year and the second earns X-Y in the first year and X+Y in the second year (+ this economy has no interest rates or inflation). Should the two fishermen pay the same amount in taxes?

If your answer is yes, then only tax systems that consist of a flat tax + guaranteed income will satisfy this fairness principle provided that income is taxed by year. It might be possible to make an absurdly complicated tax system that tries to use past income and predict future income that is non-flat and satisfies this fairness principle, but that is impractical and difficult to implement.

Edited September 11, 2015 by -1=e^ipi

[waldo]

You're in the states anyway. Don't worry about what Elections Canada does. You can't vote in our elections anyway even though the amount of time you spend on a Canadian politics forum suggests you'd like to.

bingo! The perfect retort to the repeated, ad nauseum, references to "a 2008 survey" that the guy tried to substantiate by linking to an article with content that said NOT WORD ONE about the/his oft mentioned claim!

[Bonam]

With respect to 'fairness', do you think a tax system should satisfy the following 'fairness' principle?:

Suppose you have two otherwise identical fishermen that both earn $100000 over 2 years. One earns $50000 each year and the second earns $40000 in the first year and $60000 in the second year (+ this economy has no interest rates or inflation). Should the two fishermen pay the same amount in taxes?

If your answer is yes, then how about we generalize the numbers:

Suppose you have two otherwise identical fishermen that both earn 2X over 2 years. One earns X each year and the second earns X-Y in the first year and X+Y in the second year (+ this economy has no interest rates or inflation). Should the two fishermen pay the same amount in taxes?

If your answer is yes, then only tax systems that consist of a flat tax + guaranteed income will satisfy this fairness principle provided that income is taxed by year. It might be possible to make an absurdly complicated tax system that tries to use past income and predict future income that is non-flat and satisfies this fairness principle, but that is impractical and difficult to implement.

No, if you wanted to satisfy this fairness principle you don't need a tax system that tries to predict anything, but only uses existing past data.

For example, let's say your tax rate is 20% on everything up to 50k and 30% on everything over 50k, just to use an example of a progressive income tax. Then in your example:

Fisherman A year 1: pays 10k tax

Fisherman A year 2: pays 10k tax

Total: 20k

Fisherman B year 1: pays 8k tax

Fisherman B year 2: pays 10k + 3k tax = 13k

Total: 21k

That's a difference of 1k in taxes. If you want to restore the fairness, the tax system can take past data into account and pretend that income is averaged over years, for example:

Fisherman A year 1: pays 10k tax

Fisherman A year 2: pays 10k tax

Total: 20k

Fisherman B year 1: pays 8k tax

Fisherman B year 2: since his income has changed, calculate the total income over 2 years (40k + 60k). This adds to 100k. Divide by 2 years to get the average income. This is 50k/year. With a 50k/year average income, the fisherman owes the government an average of 10k/year, which totals to 20k for the two years. The fisherman has already paid 8k, therefore he owes 12k more.'

Total: 20k

This resolves the issue, and as more years pass you can just keep extending the average over more years and maintain the total lifetime tax burden to be equivalent on any two earners with the same lifetime earnings, regardless of their variability.

That said, I don't think fairness in regards to year-to-year income variability is a necessity of the tax system. It'd be nice, but it's not key. More important would be fairness in regards to different types of income... whether they come from employment or investment.

Edited September 11, 2015 by Bonam

[msj]

That said, I don't think fairness in regards to year-to-year income variability is a necessity of the tax system. It'd be nice, but it's not key. More important would be fairness in regards to different types of income... whether they come from employment or investment.

Agreed.

One place to start on this is with stock options as explained here: https://deadfortaxreasons.wordpress.com/2015/03/30/repealing-the-employee-stock-option-deduction-and-unanswered-questions/

And considered here: http://policyoptions.irpp.org/2015/09/01/will-taxing-ceo-options-raise-much-revenue/

[-1=e^ipi]

@ Bonam - Okay, now how do you deal with immigration, inflation, interest, income splitting within households, changes in the tax system over time, etc. with your overly complicated tax system that uses tax history?

[ReeferMadness]

@ Bonam - Okay, now how do you deal with immigration, inflation, interest, income splitting within households, changes in the tax system over time, etc. with your overly complicated tax system that uses tax history?

Our tax system already has used tax history. It used to be that the child tax benefit relied on your previous year's income. There are probably other things that do as well.

[-1=e^ipi]

Our tax system already has used tax history. It used to be that the child tax benefit relied on your previous year's income. There are probably other things that do as well.

The thing is, I could have constructed the fairness argument to be 3 years, 4 years or any number of finite years and argue that 2 identical people that earn $X over N years should pay the same amount of taxes.

So you would need to keep track of someone's earnings over their entire lifetime. And this leads to many questions:

How do you deal with immigration, interest, inflation, income splitting in households, changes in the tax system over time (like say we have those 2 fisherman, but from year 1 to year 2 you change how 'progressive' the tax system is; how do you satisfy the fairness principle and allow for changing tax systems)?

What if someone goes on disability or goes into then comes out of retirement?

How much does this cost to implement and deal with fraudulent claims?

It gets overly complicated fast.

Edited September 11, 2015 by -1=e^ipi

[-1=e^ipi]

Anyway, there are better arguments for a gauranteed income + flat tax (such as Occam's razor arguments, simplification of tax code making things more efficient, and Social Welfare Optimization arguments), but Reefer in his original post has excluded these arguments. Heck, with a flat tax + guaranteed income system I can't even argue for a given level or effective progressiveness since with this system the progressiveness is directly tied to the tax level.

[-1=e^ipi]

I discussed the idea of calculating social welfare maximizing income in this thread:

www.mapleleafweb.com/forums/topic/24624-so-what-would-an-ndp-government-do/

as well as other threads.

At best, all you can do with fairness arguments is that people be treated equally. But that doesn't tell you the best type of tax system. Ultimately, you need to maximize Social Welfare, which means defining a social welfare function (though you can argue for one based on empirical data) and looking at empirical data on wage distribution.

The idea of this thread, that you can determine the optimal relative distribution of tax burden without looking at tax level is flawed. Both need to be solved simultaneously.

[TimG]

I'm lucky because I'm an accountant so I don't have to pay thousands each year for T1/T2/T4/T5 and financial statement preparation which pushes the math further in my favour.

I am surprise to hear that an accountant without employees can make >200K. I did not think that an accounting degree was a license to print money. If you have employees then that creates a huge number of risks/problems which the corporate structure is designed to manage so I don't see a problem if the corporate structure allows you to defer taxes as a side effect. Edited September 11, 2015 by TimG

[cybercoma]

Fisherman B year 1: pays 8k tax

Fisherman B year 2: since his income has changed, calculate the total income over 2 years (40k + 60k). This adds to 100k. Divide by 2 years to get the average income. This is 50k/year. With a 50k/year average income, the fisherman owes the government an average of 10k/year, which totals to 20k for the two years. The fisherman has already paid 8k, therefore he owes 12k more.'

Total: 20k

Pretty brutal scheme if one year you have a bumper crop and the next year is a bust. In the year where you just scraped by, you'll have to hope you saved enough from the bumper year to cover the massive amount of tax relative to your actual income in that year.

[msj]

I am surprise to hear that an accountant without employees can make >200K. I did not think that an accounting degree was a license to print money. If you have employees then that creates a huge number of risks/problems which the corporate structure is designed to manage so I don't see a problem if the corporate structure allows you to defer taxes as a side effect.

My partnership has plenty of employees.

It flows the net income to my company which has me as the shareholder and employee (and my wife as a shareholder).

As for risk: mitigated with professional liability insurance which I'm required to have anyway.

As for employees and partners: yes they add risk but I have to watch them whether I'm incorporated or act as an unincorporated partner so not really different.

I'm incorporated for the tax reasons as is the case for most people.

[msj]

Pretty brutal scheme if one year you have a bumper crop and the next year is a bust. In the year where you just scraped by, you'll have to hope you saved enough from the bumper year to cover the massive amount of tax relative to your actual income in that year.

Yet for businesses they are allowed to carry a loss back 3 years and to carry losses forward 20 years.

So boom/bust does happen and businesses are able to smooth out income and taxes.

Of course, the fishing industry gets the benefit of using the EI system to smooth income out whereas most other industries don't have such luck (or lobbying efforts).

[Accountability Now]

Also something called time value of money related to the deferral of tax.

I think that is just it...the benefit of having a corporation is tax deferral. I don't know your situation but I know for me that if I flush the money from my active business right through my hold co into my personal account then I pay the 38% and there is no savings. The active company normally taxes at 25% and provides eligible dividends which I can transfer tax free to my hold co as I own more than 10%. If I leave the money in there or take it out very slowly then I pay minimal taxes. However if I need the money then I have to pull it out and incite a tax event. I haven't seen too many legal ways around this. As of late I have seen people doing those life insurance/investment company method but it seems too good to be true. Essentially they claim that you can pull your money out of your hold co tax free but I have to believe that loop hole will close. I have seen similar loop holes close in the last few years.

[TimG]

As for employees and partners: yes they add risk but I have to watch them whether I'm incorporated or act as an unincorporated partner so not really different.

I was thinking about the context of this thread where people are complaining about people using a corporate structure to pay less tax than they should. You may have enough income to benefit from the tax deferral capabilities of the corporation but you are also an employer providing jobs and assuming the financial risk that comes with that activity. For that reason, I don't think anyone should have a problem with the tax benefits you receive. Edited September 11, 2015 by TimG

[Accountability Now]

This is true when companies hire individual contractors directly. However, there is a work-around (people go through a 3rd party agency). They are employees of neither the company nor the 3rd party agency.

My understanding is that to be a contractor you must prove that you work for more than one company. We used to have employees work as contractors and CRA shut that down. Now guys can work around it by billing their friend or families companies for some smaller amount and never collecting but still showing they work for more than one.

As TimG said, the system tries to achieve fairness but if certain individuals choose to break the laws then that's on them....not the system.

[Accountability Now]

but you are also an employer providing jobs and assuming the financial risk that comes with that activity. For that reason, I don't think anyone should have a problem with the tax benefits you receive.

That's the part that most people don't get. There are risks of owning and operating a business which require tax incentives such as deferral. For the most part once I pull the money out of my hold co I have essentially paid the same 38% as if I was an employee unless I spread it out over a long time which is not feasible for general life needs.

[Accountability Now]

Had a woman come in the other day with the remnants of her company with $150,000 left in it.

She could take the $150,000 out all at once and pay $36,000 in total tax.

Or spread it out over 3 years for total taxes of ~$14,000.

Or do it over 5 years for total taxes of ~$6,000.

That's her situation.

Exactly...that is her situation which may allow here to spread it out over 5 years. Maybe she had her house and cars and other major expenses paid for and can live off of $25,000 per year. In that case, great....defer the tax and pull it out over the 5 years. However others can't do that.

I've just recently got to the point where I can start deferring. Its nice. Lol.

[ToadBrother]

Ever wish you could make $47,888 tax free? Well, you can - assuming that you are wealthy enough to earn it all in dividends.

I'm clearly living in the wrong province.

[ReeferMadness]

Our tax system already has used tax history. It used to be that the child tax benefit relied on your previous year's income. There are probably other things that do as well.

Taxation of capital gains uses tax history as well. You can carry forward capital losses. You can carry forward business losses. I'm sure there are other things as well but msj would be the guy to talk to this.

[ReeferMadness]

Pretty brutal scheme if one year you have a bumper crop and the next year is a bust. In the year where you just scraped by, you'll have to hope you saved enough from the bumper year to cover the massive amount of tax relative to your actual income in that year.

No. Tax averaging is a huge advantage. I wish I could do it as an employee.

The fisherman actually pays less tax in year 2 than he would without it.

[ReeferMadness]

My understanding is that to be a contractor you must prove that you work for more than one company. We used to have employees work as contractors and CRA shut that down. Now guys can work around it by billing their friend or families companies for some smaller amount and never collecting but still showing they work for more than one.

As TimG said, the system tries to achieve fairness but if certain individuals choose to break the laws then that's on them....not the system.

WHAT? A couple of posts earlier, you're talking about how you use a holding company as a dodge to pay minimum tax and other people are using a life insurance scam to avoid paying any tax at all. But the system is fine, right?

Or are you agreeing with Tim in claiming that as long as you hire someone you feel entitled to not pay taxes?