November 7, 2020
This is part two of the two-part edition of COVID tax surprises. In the first part I discussed possible COVID-19 tax surprises from relief programs. Relief funds are generally taxable benefits so you may end up owing more taxes than usual. Additionally, CRA Requests for Information or Audits will become common for businesses that received any of the COVID relief program funds.
For this edition we will look at two other possible tax surprises that result from the economic impact caused from the worldwide pandemic.
1. Trading activity for your investments and investment income
Volatile markets may mean your taxable accounts will see higher realized capital gains than you’re used to. This sounds surprising given that the world economy has been hit hard by COVID-19 and equity valuations for many companies are down. But your portfolio may have repositioned itself to become more defensive by selling shares that you have held for a long time to be replaced by shares in companies that are more resilient or defensive. The necessary disposition of shares you’ve held for a long time may have created a sizeable realized taxable capital gain.
If you hold investments in your business, you’ll need to watch for these possible higher realized gains for an additional reason, your corporation’s Adjusted Aggregate Investment Income (AAII). Many may recall, but to refresh, the new passive investment rules that limit the amount of passive investment income you can earn corporately before reducing your small business deduction limit for your active business income in the following year. If the higher taxable capital gains reduce your Small Business Deduction room for your active business income and you could use that room, you do have a few options. You may pay out salary to yourself to reduce your active business income to the new lower level or pay the excess amount of active income that is above your new small business deduction limit out as an eligible dividend, at favorable New Brunswick rates.
2. Ability to pay Common Share Dividends by your business
This is not always obvious for small to medium size business owners, but because of the economic impact of COVID-19 your business may be worth less and your common shares could be “underwater”. Underwater doesn’t mean your company is bankrupt but rather means now you owe more than your common shares are worth. This is common for businesses that have recently conducted an estate freeze and shareholders have significant value of the company locked in on preferred shares (or freeze shares). Example, your 7-million-dollar company is now worth 4 million because of COVID. There is $5M in value attributable to the preferred shares from an estate freeze you did three years ago. You cannot legally pay a dividend on the common shares until the value of the company climbs above the $5M mark unless you do what’s often referred to as a thaw and refreeze.
A refreeze strategy can be beneficial as new lower valuations on the preferred shares mean less tax on death of the preferred share owners. For businesses that weather Covid-19 and start to grow again, it could be an opportunity to defer some taxes to your next generation.
This writing is for general information purposes only and is not intended to provide legal, accounting, tax or professional advice. Any opinions expressed are my own and may not necessarily reflect those of Louisbourg Investments.
Author:
Jared Burns CPA, CA is an estate and tax planning manager with Louisbourg Investments. Comments or questions may be submitted to jared.burns@louisbourg.net.