Maybe Not a Capital Idea After All.
PART 1 of 2
Many of our regular readers are aware that the recent budget proposed to increase the “capital gains* inclusion rate” from 50% to 67% (with an exception for the first $250k of gains realized by an individual). This affects gains realized after June 25, 2024.
Many of our regular readers are also very confused and worried by it. I know this because many of our regular readers have been in touch. In late April. When we have nothing else to do, anyway…
[*Acronym: CG = Capital Gains… the difference between what you receive on sale of an asset, and your fully-loaded cost (including transaction costs, renovations, etc.)]
I apologize that this is a long post. In fact, it’s so long that this is a 2-parter. But there’s a lot to unpick here.
[A big caveat: We’ve not seen draft legislation yet. This is based on what’s published as of today.]
Let’s start by clearing up a few misconceptions or misunderstandings….
What does this actually mean?
This does NOT mean that you will be paying a tax rate of 67% on anything you sell.
The inclusion rate means how much of the gain is actually included in your income, when calculating how much tax you owe. So, for example, earned income (salary, self-employment income) etc. has a 100% inclusion rate. Meaning that if you earn $80k, it adds $80k to your taxable income.
The inclusion rate on CGs has been at 50% since 1999. Meaning that if you realized a CG of $80k, only 50% – or $40k of that – is added to your taxable income. The other $40k is free of tax. [By the way… the inclusion rate was 67% in 1988-89, and 75% from 1990-99. So I guess we’re going back to the future…]
Your actual tax will depend on your tax bracket.
If you are a higher rate taxpayer in Ontario (meaning, >$150k income), then your marginal tax rate is effectively 50%. Meaning, you’ll pay $0.50 on every $1 of earned income. Because of the inclusion rate, you’d previously pay $0.25 on every $1 of capital gains. Now (after the first $250k), you’ll pay $0.33 on every $1 of capital gains.
So…. Irritating and you’ll notice it. Not necessarily a disaster.
Also, for most people, their most significant asset – and their most significant gain – is their home. That remains completely exempt from tax on CG. But don’t forget to declare the sale and sign off the relevant info in your tax return, in the year you sell it.
Let’s acknowledge this first… The government has said this will affect only the richest of Canadians. I quibble with their calculations and how they define “rich”…. but I acknowledge that many people will think, “Well, cry me a river. I’m never even going to be able to buy a house. I’d love to have these problems.”
So, from a social equity perspective, I can certainly understand the reasons for this change. That said…
I don’t want to come across as tone-deaf. But… many of the people who will be affected by this don’t feel rich, or think of themselves that way. And many of our clients have taken significant risks to get to where they were. They’ve put their house on the line to meet payroll. They went years without a decent paycheque to build their business. And that’s not just a cliche.
OK, so will this affect me?
More people pay CG tax than you might think. (Trust me, I see the returns). But most of the time, as an individual, you’re unlikely to hit the $250k threshold, that triggers more tax than in the past.
Many middle-class families are going to pay more tax when somebody passes away. A death can trigger a large CG tax bill in the year of death, that takes you above the $250k threshold.
Let’s take a family that’s comfortable, but by no means in the top 1%:
- Mom passes away (2 years after Dad) and leaves her kids a cottage worth $500k (cost: $200k), a rental property worth $300k (cost: $150k), and some investments worth $200k (cost: $100k). That’s a $1m estate – comfortable, but definitely not top 1%.
- For simplicity, let’s say that Mom’s pension and other income was $90k in the year she died.
- Previously, CG tax would have been $137,500. Under the new rules, $163,000. (A prize for the first person to send me their workings).
So, that’s an increase of $25,500, on a $1m estate. As I said before, you’ll notice it. But it’s not confiscation.
Doesn’t mean you’ll like it, though.
For the attention of business owners…
It does get worse if Mom’s assets were held in a corporation, not her own name. And that’s the reality for many small or medium-sized business owners, the unsung heroes who are the backbone of our local economy.
If all these assets were held in a corporation, then you now have an inclusion rate of 67% from the first dollar. Not the $250,001st dollar. If this was you, the tax on mom’s estate would have gone from $137,500 to $184,250. That’s an increase of $46,750. I’d notice that much more.
By the way…. This different treatment between individual and corporate ownership is what’s got me and many other accountants very hot under the collar. To this point, our tax system has been built on a technical concept called “integration”. Without going into detail, it means that you should ultimately pay the same tax on income and assets, regardless if you hold them personally or in a corporation. For the first time, this change – specifically the $250k available only to individuals – has broken integration. It may not sound like much…. but it will introduce much more complexity, randomness, and unfairness into how our tax system operates. And make it much harder to help our clients plan for their retirement, their dreams, etc…
So… what should I do?
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Sorry, this post is already TLDR. Come back next week.