Is Passive Income Eating Away At Your Small Business Deduction?

Is Passive Income Eating Away At Your Small Business Deduction?

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Latella & Bastone Financial Group - Blog - Is Passive Income Eating Away At Your Small Business Deduction?

Small Businesses Play A Significant Factor in Driving the Canadian Economy

Small businesses play a significant factor in driving the Canadian economy. If you have an incorporated business, there can be tax advantages as up to $500,000 of active business income left inside a corporation is taxed at a low small business tax rate. However, in 2018 the federal government introduced changes to passive income rules (generated from rents, investments, or dividends) that may impact how much money businesses can receive at that preferential tax rate. These new rules took effect for corporations whose year-end is on or after January 1, 2019. Business owners need to be aware of the change and its impact on your corporate tax rate and ensure they have a good tax planning strategy in place.

The small business limit (the amount of income annually eligible for the small business rate) is $500,000 federally and in most provinces. The changes that went into effect in 2019 reduce the small business limit by $5 for every $1 of investment income above a $50,000 threshold. Under this formula, the SBD will be eliminated when investment income reaches $150,000 in a given taxation year. The chart below shows the reduction of the small business limit at selected passive income levels.

Is losing the small business deferral significant? The answer is not always black and white and depends on your specific situation. If you are going to take the after-tax business income out of the company in the year it’s earned, you’re not deferring tax; the SBD reduction or loss is then probably immaterial.

The good news is that if you have a Canadian-controlled private corporation (CCPC) that does not earn any business income that could be taxed at the SBD Rate, the new tax rules for passive income will not affect you at all. For example, if you have a holding company (or other CCPC) that earns only passive investment income, you cannot lose access to the SBD because you have no active business income.

Quebec Based Financial Group

When it comes to tax planning and understanding the impact of passive income on your tax rate, it is critical to work with a tax professional who can develop an appropriate strategy for you. Depending on your situation and business structure, passive income could be increasing your corporate tax from 14%-26%.