Capital Gains Inclusion Rate Reforms - 2024
CAPITAL GAINS INCLUSION RATE INCREASE FEDERAL BUDGET 2024 – FAIRNESS FOR EVERY GENERATION
EXECUTIVE SUMMARY
On April 16th, 2024 the Federal Government released the Fairness for Every Generation budget which aims to address a number of issues facing Canada currently, namely cost of living and housing affordability. The budget also introduced a number of tax reforms through the increasing the capital gains inclusion rate for high-income earners and corporations. As of June 25th,2024 the inclusion rate for capital gains exceeding $250,000 for individuals and corporations will increase to 66.67%. The increased inclusion rate will be applied to any capital gains over $250,000 recognized through the sale of capital assets, sale of business, sale of non-primary residence, funds provided through a trust and gains recognized through the estate of an individual who has passed away. This briefing provides an overview of the capital gains tax reform announced in the budget, if you stand to be affected by the changes JKS recommends that you consult a tax professional for advice.
CAPITAL GAINS INCLUSION RATE REFORM
The Canada Federal Budget 2024 introduces significant changes to capital gains tax rules aimed at enhancing tax fairness and supporting entrepreneurship. Here are the key insights:
Increased Inclusion Rate for High-Income Earners and Corporations:
The inclusion rate for capital gains exceeding $250,000 per year for individuals, as well as all capital gains for corporations and trusts, will increase from 50% to 66.67% starting June 25, 2024 .
For individuals, capital gains up to $250,000 per year will continue to be taxed at the existing 50% inclusion rate .
Enhanced Lifetime Capital Gains Exemption:
The lifetime capital gains exemption, applicable to small business shares and farming or fishing property, will be raised from $1,016,836 to $1.25 million, also effective from June 25, 2024. This exemption will continue to be indexed to inflation .
Exemption for Principal Residence:
Gains from the sale of a principal residence will remain exempt from capital gains tax, preserving a significant tax relief for homeowners .
Treatment of Property Flipping:
As of January 1, 2023, gains from property flipping (properties bought and sold within a year) are classified as business income, aiming to discourage speculative real estate investments .
Canadian Entrepreneurs' Incentive:
To foster entrepreneurship, a new incentive will reduce the inclusion rate to 33.3% for up to $2 million in eligible capital gains over a lifetime. This is designed to benefit entrepreneurs selling their businesses, providing a combined tax advantage with the enhanced lifetime exemption potentially totaling at least $3.25 million.
CONSIDERATIONS FOR BUSINESS OWNERS
Dividend vs. Salary Considerations:
With increased capital gains taxes, business owners might reassess how they extract profits from their businesses. Typically, owners have to decide between paying themselves a salary or dividends. Since dividends might come from after-tax corporate income, they are often taxed at a lower personal rate compared to salary. However, salaries allow for RRSP contributions and generate payroll taxes that dividends do not. The new capital gains rate might make keeping more money within the corporation (to be later distributed as dividends) a more attractive option, depending on individual tax situations and the integration of personal and corporate tax rates.
Impact on Business Sale and Retirement Planning:
If a business owner plans to sell their business, the new capital gains rules might affect the timing of the sale and how they plan their retirement. Increased taxes on capital gains could reduce the net proceeds from the sale of the business, which in turn could impact how much owners will rely on salary or regular withdrawals from business profits before selling.
Reinvestment Decisions:
Higher capital gains taxes might encourage business owners to reinvest profits back into the business rather than taking them out as personal income. This could lead to changes in how owners pay themselves, potentially reducing their direct compensation in favor of reinvesting in the business for growth, which might yield better long-term benefits.
Tax Planning:
Business owners will need to engage in more sophisticated tax planning to manage their tax liabilities effectively. This might include altering the structure of their income to optimize for lower tax brackets or making use of various allowed deductions and tax credits more strategically.
CONSIDERATIONS FOR ESTATE PLANNING
Increased Capital Gains Tax at Death:
In Canada, when a person dies, they are deemed to have disposed of their assets at their fair market value immediately before death. This "deemed disposition" can result in a capital gains tax liability on assets such as real estate, stocks, or business interests that have appreciated in value. With the increase in the capital gains inclusion rate from 50% to 66.67% for individuals on gains exceeding $250,000, and for all gains by corporations and trusts, the tax burden on the estate could be significantly higher. This means that more of the estate’s value could be consumed by taxes, reducing the amount passed on to heirs.
Impact on Estate Planning:
Individuals might need to revise their estate plans to account for the higher potential tax burdens. This could involve more sophisticated strategies such as freezing the value of their estate through an estate freeze, where future gains are accrued to the benefit of the next generation, or by using life insurance policies to cover expected tax liabilities.
Use of the Lifetime Capital Gains Exemption:
The lifetime capital gains exemption (LCGE) has been increased to $1.25 million for qualified small business corporation shares and certain types of farm or fishing property. This exemption can be planned for use to minimize the deemed disposition impacts at death, particularly if the assets qualify under these categories.
Strategies for Minimizing Estate Tax:
Given the higher tax rates on capital gains, strategies to minimize estate tax might become more attractive. These could include gifting assets during the owner’s lifetime to spread and possibly reduce overall capital gains taxes or setting up trusts that might be taxed differently and could provide better tax outcomes under certain conditions.
Re-evaluation of Asset Holding Structures:
Business owners and individuals with significant investment assets might consider different corporate structures or the use of holding companies and family trusts to optimize for tax efficiency upon their passing. This is particularly relevant for planning around the new capital gains tax rates for trusts and corporations.
Consideration of Charitable Donations:
Charitable giving as part of an estate plan could also be an attractive option, as donations can be used to offset capital gains tax liabilities. Large charitable donations could therefore not only fulfill philanthropic goals but also reduce the tax burden on the estate.
CONSIDERATION FOR TRUSTS
Higher Inclusion Rate for Trusts:
The capital gains inclusion rate for trusts will increase from 50% to 66.67%. This change aligns the rate for trusts with the new rate for corporations and affects all capital gains realized by trusts. This means that trusts will now pay more tax on any gains from the sale of assets they hold, reducing the net amount available for distribution to beneficiaries.
Impact on Estate Freezes:
An estate freeze is a common strategy used to lock in the current value of an individual’s estate for tax purposes, with future growth accruing to the benefit of the next generation, often through a trust. The higher capital gains tax rate could make this strategy less attractive, as the tax burden on future gains would be higher. This might lead individuals to consider alternative strategies or structures.
Realization of Capital Gains Within Trusts:
Since trusts are also subject to deemed disposition rules — similar to individuals — the assets held within a trust are considered sold for their fair market value every 21 years. The increase in the capital gains tax rate means that trusts will face a higher tax liability on these deemed dispositions, which could lead to a substantial financial impact if not planned for properly.
Distributions to Beneficiaries:
Trusts often distribute income, including realized capital gains, to beneficiaries. While the income and gains are taxed in the hands of the beneficiaries, the increase in the tax rate means that the overall financial benefit received from such distributions could be lower. Beneficiaries receiving these gains will need to account for higher tax liabilities.
Inter-Vivos and Testamentary Trusts:
The effects will differ based on the type of trust. Inter-vivos trusts (created during a settlor's lifetime) and testamentary trusts (created as a result of a will upon death) may both need to adjust their strategies to accommodate the new tax rate. For example, testamentary trusts, which often benefit from being taxed at progressive individual rates, may need revisiting to optimize tax planning under the new rules.
Planning for Future Trust Contributions and Withdrawals:
Given the higher tax implications, trustees might need to reconsider the timing of asset sales and distributions. This could involve delaying asset sales where feasible or accelerating them in certain cases before the higher rates fully take effect.
Use of Charitable Remainder Trusts:
This might increase the attractiveness of charitable remainder trusts, where a charity is named as the ultimate beneficiary, as part of an effort to manage taxable gains within a trust structure efficiently.
RECOMMENDATION – CONSULT A TAX PROFESSIONAL
The changes to the capital gains tax could potentially have a significant impact on an individual’s business, retirement and legacy planning. JKS recommends that anyone who believes they may be impacted by these changes consult a tax professional for an assessment based on their specific situation.
