How will the 2024 federal budget impact professionals?
How will the 2024 federal budget impact professionals?
The measures introduced in the 2024 federal budget may have a significant impact on professionals. It is important to understand these five measures:
- The increase in the capital gains inclusion rate
- The increase to the lifetime capital gains exemption
- Further changes to the Alternative Minimum Tax
- The introduction of the Canadian Entrepreneurs’ Incentive
- Proposals relating to employee ownership trusts
The 2024 federal budget (Budget 2024), entitled Fairness for Every Generation, was delivered by the Honourable Chrystia Freeland, Deputy Prime Minister and Minister of Finance, on April 16, 2024.
This article will comment on five measures from Budget 2024 that will impact professionals, including:
- The increase in the capital gains inclusion rate from 50 percent to 66.67 percent
- The increase to the lifetime capital gains exemption (LCGE)
- Further changes to the Alternative Minimum Tax (AMT)
- The introduction of the Canadian Entrepreneurs’ Incentive, and
- Proposals relating to employee ownership trusts (EOTs)
The information contained in this article is current to April 30, 2024. It is important to note that, with the exception of the AMT and EOT proposals, no draft legislation has been released to date with respect to the measures mentioned above. In terms of the capital gains inclusion rate, the government was clear that additional design details are forthcoming and that other consequential amendments would also be made to reflect the new inclusion rate.
Furthermore, any planning undertaken in respect of these measures should also take into consideration the pending changes to other tax measures, including AMT and the General Anti-Avoidance Rule.
Capital Gains Inclusion Rate
The capital gains inclusion rate for capital gains realized on or after June 25, 2024, will increase from one-half (50 percent) to two-thirds (66.67 percent) for trusts and corporations.
The capital gains inclusion rate for capital gains realized on or after June 25, 2024, will also increase from one-half (50 percent) to two-thirds (66.67 percent) for individuals on the portion of capital gains realized in the year exceeding a $250,000 threshold.
The $250,000 threshold would effectively apply to capital gains realized by an individual (not a corporation), either directly or indirectly via a partnership or trust, net of any:
- current-year capital losses
- capital losses of other years applied to reduce current-year capital gains, and
- capital gains in respect of the LCGE, the proposed Canadian Entrepreneurs’ Incentive exemption, or the proposed EOT exemption
The change in the capital gains inclusion rate is significant for a professional as it may result in more income tax being paid when capital gains are realized. Capital gains typically accrue on savings that are invested for retirement purposes (e.g., stocks, bonds), in real property that is utilized for the practice (or for investment purposes), and in private company shares.
For many professionals, their net worth (except for personal assets such as a principal residence) often accrues within a corporation and not always at the personal level. This occurs because the corporation is an effective way to save for retirement or invest in business assets.
For example, in British Columbia (B.C.), one dollar of earnings not required for personal spending typically results in $0.89 of after-tax money (assuming the small business deduction applies) to invest in the corporation.
If this same dollar was earned in the absence of a corporation, the professional would only have $0.465 of after-tax money to invest (assuming the highest marginal rates of tax apply). The large difference in after-tax funds available for either corporate or personal investment plays a significant role as to why there is a preference for net worth to accrue in a corporation.
Corporate investment portfolio (retirement savings in the form of stocks, bonds, etc.)
Consider a doctor who resides in B.C. and has been saving and investing in the professional corporation for many years because they do not have a pension plan. This doctor is subject to the highest marginal tax rates and the professional corporation currently has an unrealized capital gain of $100,000.
If the doctor’s professional corporation sells the investment and incurs a capital gain before June 25, 2024, and pays a tax-free capital dividend and taxable dividend to the doctor, they would have $70,440 of after-tax personal dollars.
If the doctor’s professional corporation realizes the $100,000 capital gain on or after June 25, 2024, and pays a tax-free capital dividend and taxable dividend to the doctor, they would have $60,691 of after-tax personal dollars to spend.
The after-tax dollar difference is significant at the personal level. If the doctor requires $70,440 to meet their personal needs, they would need to draw another $21,000 from the professional corporation. They would have to draw this amount via a salary or a $20,000 non-eligible dividend to meet the personal cash shortfall of $9,749 ($70,440 less $60,691).
In short, if a capital gain was realized and the amounts were distributed via a tax-free capital dividend and a taxable dividend, the doctor would have to remove approximately $121,000 (including an extra bonus) on or after June 25, 2024, from the professional corporation to meet the after-tax targeted amount of $70,440.
In contrast, the doctor would only need to withdraw $100,000 from the professional corporation if the current capital gains inclusion rate of 50 percent was the relevant rate when the capital gain was realized, and the dividends were paid.
Notably, a $100,000 capital gain would result in the doctor’s professional corporation having to recognise $50,000 of adjusted aggregate investment income (AAII). The same gain realized on or after June 25, 2024, would require the professional corporation to recognize $66,667 of AAII.
AAII is significant because each dollar of AAII that exceeds $50,000 reduces the doctor’s ability to utilize the small business tax rate (11 percent in B.C.). Instead, it requires a corporation to pay taxes at 27 percent, which may diminish a corporation’s ability to defer taxes on future earnings.
MNP Insights:
- Understand whether the change in the inclusion rate will materially impact retirement planning, as more tax will be payable when assets are sold to fund lifestyle needs or retirement.
- Consider whether it is advisable to realize gains (or rebalance the portfolio) prior to June 25, 2024, in order to save tax.
- Consider whether the capital gains will have an impact on the small business deduction available in future years.
In the context of realizing an accrued gain, a professional should consider whether their net wealth is enhanced or diminished. In some cases, the analysis will be clear, and gains should be realized prior to June 25, 2024, and capital should be distributed from the corporation. In other cases, the analysis will indicate that the professional should leave the accrued gain and realize the gain later.
If a professional requires personal cash from their professional corporation soon, there could be some urgency to consider the implications of the change in the capital gains inclusion rate and whether there are opportunities to reconsider their compensation planning.
Real property
Real property owned by a corporation (in B.C.) would be subject to the same tax results as an investment portfolio as it relates to a capital gain. For example, the following table outlines the tax difference if real property was sold with a $1 million capital gain before June 25, 2024, versus a capital gain realized on or after June 25, 2024.
| Item | Before June 25, 2024 | On or after June 25, 2024 |
|---|---|---|
| Capital gain | $1,000,000 | $1,000,000 |
| Inclusion rate | 50% | 66.67% |
| Taxable capital gain | $500,000 |
$666,700 |
| Corporate and personal tax on full distribution |
$(295,600) |
$(393,089) |
| After tax personal funds |
$704,400 |
$606,911 |
| Difference |
$(97,489) |
- |
For simplicity, the table above does not consider capital cost allowance (tax depreciation).
A capital gain of $1 million realized in a corporation holding a building will result in $97,489 of additional tax after June 24, 2024.
MNP Insights:
The change to the capital gains inclusion rate will result in a higher income tax liability on or after June 25, 2024. As a result, professionals need to:
- Consider whether it is advisable (time value of money, property transfer tax, GST) to realize a capital gain by removing real property from a practice and transferring it to a holding company prior to June 25, 2024.
- Seek advice if you have a capital gains reserve from an earlier sale of capital property.
Private company shares and personal property
The sale of private company shares is more relevant in certain professions when compared to others. For example, a dentist and optometrist often sell the shares of their professional corporation when a practice is sold. For physicians, this is seldom the case as a market generally does not exist for buying and selling medical practices.
When an individual sells shares on or after June 25, 2024, the inclusion rate will be 66.67 percent. However, unlike a corporation, an individual will have access to an annual $250,000 threshold which allows the individual to include the first $250,000 of the capital gain in their income at a rate of 50 percent and not 66.67 percent.
MNP Insights:
- A person who died is considered to have disposed of all the property immediately before death. For example, a dentist’s net capital gain is included in their income, unless a spousal rollover applies. The net capital gain will be included at 66.67 percent (subject to the $250,000 threshold) rather than 50 percent. The change in the inclusion rate may have a material impact on a dentist’s estate plan.
- Investment properties or recreational properties will also be subject to this new change to the extent the principal residence exemption does not apply.
Lifetime Capital Gains Exemption
Budget 2024 proposes to increase the LCGE to $1.25 million (from $1.016 million) of eligible capital gains. This measure would apply to dispositions that occur on or after June 25, 2024, and is welcome news for professionals that have a market in which they can sell their private corporation shares.
The LCGE is available only to individuals who sell shares of a qualified small business corporation (QSBC). In addition to the enhanced exemption of $1.25 million, an individual can also benefit from the $250,000 capital gains inclusion rate threshold. In most provinces, before considering AMT, the increased exemption (fully utilized) will translate into approximately $423,500 of tax savings when compared to paying taxes at the highest marginal rates assuming the $250,000 threshold applies.
MNP Insights:
- The increase to the capital gains inclusion rate creates further emphasis on the LCGE’s importance. Shares that are not QSBC shares will be subject to the 66.67 percent inclusion rate (over and above the $250,000 threshold) rather than being exempt from income tax where the LCGE can be utilized.
- If a professional has a market for the shares of their professional corporation, the professional should ensure that the shares qualify as QSBC shares.
- The professional should ensure that, where appropriate, family members are holding shares that accrue value so that the LCGE and the threshold can be accessed by each in the event of a sale.
Alternative Minimum Tax
The 2023 federal budget introduced amendments to significantly change the AMT calculation. AMT is calculated in parallel with an individual’s regular income tax liability, but it allows for fewer tax credits, deductions, and exemptions when compared to the ordinary personal income tax rules. Taxpayers pay the higher of the ordinary tax or the AMT liability.
MNP Insights:
- Budget 2024 proposes several technical amendments to the AMT legislative proposals from 2023.
- AMT only applies to individuals (not corporations). Individuals will need to consider the impacts of AMT when capital gains are realized, or donations are made.
- Details are forthcoming. It appears that the increase to the capital gains inclusion rate may negate the application of the AMT liability as forecasted by the government in 2023.
Canadian Entrepreneurs’ Incentive
Budget 2024 introduces the Canadian Entrepreneurs’ Incentive to reduce the tax rate on capital gains resulting from the disposition of qualifying shares of a corporation by an eligible individual.
This new tax initiative allows a one-third capital gains inclusion rate on up to $2 million of capital gains. However, this program does not begin until 2025 and it will be phased in at a rate of $200,000 per year.
Specific conditions apply, including that the claimant was a founding investor at the time the corporation was initially capitalized. The assets of the business will also have to pass certain tests.
MNP Insights:
- Professional corporations are specifically excluded from this incentive.
Employee Ownership Trusts
The 2023 federal budget proposed tax rules to facilitate the creation of EOTs. The 2023 Fall Economic Statement proposed to exempt the first $10 million in capital gains realized on the sale of shares to an EOT from taxation, subject to certain conditions. Budget 2024 provided further insights into this proposal.
MNP Insights:
- Professional corporations are specifically excluded from this incentive.
Take the next steps
For more information about how the 2024 federal budget will impact professionals, contact a member of MNP’s Tax Services or Professionals teams.
Nicholas Talarico CPA, CA
Partner, Taxation Services
Marty Clement CPA,CA
Partner, Regional Leader, Professional Services
Michael Saxe CPA, CA, TEP, LL.M
Partner, Taxation Services
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