Weekend Reading: Income Sprinkling Edition

This week Federal Finance Minister Bill Morneau took aim at a tax strategy used by small businesses and private corporations called income sprinkling. Under current rules, anyone who owns shares in a private corporation can receive dividends without having to actual contribute to the business. Small business owners use dividend sprinkling to pay their lower income or stay-at-home spouse (or adult children) and reduce their overall tax bill.

The proposed rule changes, to be effective in 2018, are said to target wealthy business owners, doctors, dentists, etc., who take advantage of these tax strategies to withdraw income at a lower rate rather than reinvest money in their business. Unintended consequences, however, would affect small business owners like me.

Income Sprinkling

I have a full-time day job and run my online business at night and on the weekends. My wife stays at home full-time. Because we’re taxed in Canada on an individual basis rather than by household income, we use income sprinkling as a way to lower our overall tax bill. Without it, any money earned online would be taxed at my top marginal rate. The ability to pay dividends to my wife through our small business significantly reduces our tax bill.

After reading this excellent summary by Jamie Golombek, the good news (I think!) is that under the new proposed rules there will be a ‘reasonableness’ test in which the adult family member receiving dividends will be expected to contribute to the business, either in labour or capital, to be exempt from the new tax on income splitting.

I say good news because with our youngest child going into Kindergarten this fall, my wife will be working part-time to help me grow our business. Here’s hoping whatever changes come to pass in 2018, coupled with our new working arrangement, will allow us to continue using income sprinkling to save taxes on our household income.

This Week’s Recap:

On Monday I explored the question, how much do you need to save for retirement?

On Wednesday Marie looked at the credit card minimum monthly payment trap.

And on Friday I compared our experience hosting a kids’ birthday party at a gymnastics facility vs. McDonald’s.

Nest Wealth offer:

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Nest Wealth’s unique selling proposition, or what sets it apart from the other robo-advisors, is that its fees are charged as a monthly subscription, rather than as a percentage of assets. We compare this in our review of Nest Wealth and Wealthsimple.

Plans start at $20 per month and are capped at just $80 per month.

While this fee structure can be unappealing for those just starting out in their investing journey, it’s ideal for larger portfolios. Say, for example, your portfolio is worth $500,000 and you pay an average MER of 1.6 percent (low for Canadian investors). That means you’re paying $8,000 in mutual fund fees every single year! With Nest Wealth, you’d pay $80 per month, or just $960 per year.

Try Nest Wealth free for three months and see the difference for yourself.

Weekend Reading:

I use Canadian-listed ETFs in my own two-ETF retirement portfolio. This simplicity comes at a cost, however, as the dividends from the U.S. and International stocks held within those ETFs are subject to a 15 percent withholding tax.

In this post, Dan Bortolotti explains whether it’s worthwhile to buy U.S.-listed ETFs to save on foreign withholding taxes and access cheaper funds.

Million Dollar Journey blogger Frugal Trader explains how to convert Canadian dollars to U.S. dollars using DLR or DLR.U.

A reality check for newbie index investors about surviving the next market crash.

Michael James describes the dangers of personifying the stock market, as if Mr. Market has its own free will.

Kate Smalley lists the top five myths about traditional investment advisors:

You get what you pay for: But when it comes to investing in the stock market? There’s no proven relationship between the fees you pay and the quality of advice you receive. Or the size of your returns.

The Canadian housing market took a step back last month, falling by the largest amount in seven years.

Sorry, nobody wants your parents’ stuff. That was apparent after the Next Avenue blog received over 5,500 comments and tips on this topic.

Old people sometimes feel guilty about the resources they use. This essay by 85-year-old Robert Fulford asks, “Am I worth the expense?”

Jason Heath looks at CPP and OAS entitlements after the death of a spouse.

Speaking of entitlements, the new Canada Child Benefit is a win for most families, with 90 percent receiving more than they did from the previous CCTB and UCCB payments.

Rob Carrick says if you’ve got a Defined Contribution plan, let Sears Canada demonstrate a big advantage of this type of pension.

Canadian business owners want the right to impose a surcharge on credit card transactions. Britain just outlawed the practice, ending a rip-off that cost Britons hundreds of millions of pounds per year. Who would’ve thought corporations couldn’t be trusted to impose reasonable fees and not gouge their customers?

Finally, from $2 billion to zero: A private-equity fund that borrowed heavily to finance oil & gas wells before energy prices plummeted is now worth essentially nothing.

Have a great weekend, everyone!

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  1. David on July 23, 2017 at 9:01 am

    Sorry, can’t agree with you. I am fed up subsidizing self employed, small business etc etc via my taxes. If everyone paid their fair share perhaps we all might have more in our pockets to sprinkle into the general national economy. AND don’t get me going about the super rich who have more tax avoidance wrinkles than an unironed shirt.

    • Grant on July 23, 2017 at 7:09 pm

      David, the small business tax rules are designed to encourage people to risk their capital in order to start businesses which creates jobs and grows the economy. Take those incentives away and less people will do so.

  2. Grant on July 23, 2017 at 7:04 pm

    Rob, are saying it’s OK for the government to go after doctors and dentists so long as they don’t go after you, too…!:)

    If your wife is helping you grow the business, you can pay her a salary for those services, which also creates more RRSP room, regardless of what happens with dividend sprinkling.

  3. Tricia on July 23, 2017 at 7:07 pm

    Agree with David. This hard working, self-supporting single person is fed up with boutique tax cuts that target families, and tax reduction strategies that benefit business. Canadians need to face the reality that if we are to retain high quality health care. education, and well maintained public infrastructure everyone needs to pay to pay their fair share of taxes.

  4. Echo on July 24, 2017 at 7:59 am

    I didn’t offer my opinion on the proposed changes (likely positive, overall). Just how it might affect a small business owner like me who uses income sprinkling to lower our household tax bill.

    Re: Paying our fair share. ‘Fairness’ is subjective. Is it fair that a single-income family earning $80,000 per year pays more tax than a dual-income couple earning $40,000 each?

    @Grant – I’ve considered paying a salary for the reasons you suggest, but I’d need to look at the pros and cons of having to also pay CPP, etc.

  5. Richard on July 25, 2017 at 4:29 pm

    Not to worry, the ultra-wealthy will still find lots of ways to avoid taxes! Hopefully your MP will be hearing about how this affects you.

  6. Rick on July 28, 2017 at 10:49 am

    Sorry guys, just an unrelated question. How can an average investor purchase the VIX in their online account? The best option I have found thus far is VXX, but this seems to be an ETF, and does not correlate with the actual VIX. Is the VIX only traded though Institutional investment companies? Thanks,Rick.

    • Echo on July 29, 2017 at 9:18 am

      Hi Rick, you can’t actually purchase the VIX. The ETFs that “track” it are tracking short or medium term futures contracts, or bets on where the VIX will trade one month or one year from now. The actual explanation is much more complicated but here is a good rundown: http://www.etf.com/sections/blog/understanding-vix-etfs?nopaging=1

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