Help wealthy clients adapt to Budget 2013

Several measures in this year’s federal budget may increase taxes for wealthy clients. Here are three areas to watch:

• Problem: Increased taxes on dividends

  Solution: Consider accelerating withdrawals from private companies

  The budget has increased the federal tax rate on non-eligible dividends; this will affect dividends paid after 2013. Private companies typically pay these dividends out of small business or investment income.

  At the top tax rate, federal tax will rise 1.64% (and each province sets its own rate). Business owners who want to withdraw funds in 2014 should consider taking money now if their combined federal and provincial rates will be higher next year. That move could save them 2%.

  Read: 2013 Budget: Not much good tax news

  Provincially speaking, Manitoba will not raise its rate, but Ontario will—for a total increase between 2.13% and 2.35% in the top brackets. The jump’s even starker in B.C., which introduced a temporary tax bracket for people making more than $150,000 in 2014 and 2015.

• Problem: Synthetic dispositions not allowed

  Solution: Sell down concentrated positions or incorporate them into philanthropic plans

  More budget adjustments

  Here’s a sampling of other changes:

  Expanded disclosure on form T1135, Foreign Income Verification Statement. CRA is targeting foreign investments, so make sure clients are accurately reporting them in their returns.

  Increase in lifetime capital gains exemption. This exemption for business owners will increase to $800,000 (from $750,000) for 2014 and be indexed annually for inflation.

  Synthetic dispositions let an owner retain an asset’s title while transferring its economic losses and benefits to someone else.

  Here’s how that works. Say your client sells her private company shares to a public company called Pubco. By doing this, she likely received a significant position in Pubco and qualified for a tax-deferred rollover.

  Your client is better off locking in the gain and using the proceeds so she’s not subject to fluctuations in Pubco’s purchase price. To do that, she could enter into a loan arrangement with a financial institution that’s equal to the current fair market value of the Pubco shares.

  Read: Party’s over for tax-advantaged investing

  At the same time, she could enter into a put/call arrangement with the lender to sell the Pubco shares for an amount equal to the loan (plus any interest and dividends paid on the shares in the intervening period). This transfers the Pubco shares’ potential benefits or losses to the lender.

  This will no longer be allowed for agreements entered into after March 21, 2013. Instead, it will be as if the client disposed of the property at fair market value and reacquired it immediately afterward. And that will trigger capital gains tax.

  To offset this, the client could sell her position over time. She could also gift some of the shares and get a tax writeoff. If she holds onto the shares, her wealth will be concentrated in Pubco, so you may also want to hedge her exposure.

• Problem: Possible tax rate increase on testamentary trusts

  Solution: Allocate trust income to beneficiaries in lower tax brackets

  The Department of Finance is concerned that people are taking advantage of the lower rates testamentary trusts pay, and eroding the tax base.

  So revisit existing plans to ensure clients can wind up certain trusts in case the cost of keeping them ultimately outweighs the benefit. If a trust exists for a non-tax reason (e.g., to protect assets), consider distributing income each year to beneficiaries in lower tax brackets.

Stella Gasparro, CPA, CA, a tax and assurance specialist at MNP LLP.