There is nothing in the world that I hate more than taxes. I hate taxes so much that I get frustrated during tax season when I discover how much of my income is lost to the government.
For my fellow Fools that also hate taxes, listen up: I have a trick that will save you tens of thousands of dollars in taxes.
The strategy I am referring to is the creation of a Canadian-controlled private corporation (CCPC). With a CCPC, the corporation can claim the small business deduction (for the first $500,000 of active business income), which brings down the net tax rate to 9% — yes, you read that correctly: 9%!
If you have money set aside for investing that you don’t need access to for several years, the creation of a CCPC is the way to go. This is because capital gains made through the corporation will be taxed at 9% compared to the 25% tax rate you would be paying on capital gains (assuming the highest income bracket with the standard 50% capital gains tax).
For those of you that have maxed out your RRSP or TFSA contribution room or want the flexibility of withdrawing money (as dividends from the corporation) without paying a penalty, consider creating a CCPC. If you don’t want any dividends, leave it in the corporation, and you will be paying $0 in income taxes from capital gains.
Let’s look at Shopify (TSX:SHOP)(NYSE:SHOP) to see how much money you could save.
Since the beginning of the year, Shopify’s share price has increased 139% to date. For those of you unfamiliar with Shopify, it is a Canadian company that provides a cloud-based commerce platform for small- and medium-sized businesses.
If you’d invested $100,000 in Shopify at the beginning of the year, it would be worth $239,352 today! That sounds like a great return, but factoring in a capital gains tax of 50% in the highest income bracket would result in taxes of $34,838! Talk about a scam.
If this investment was made in a CCPC, the $139,352 of capital gains would be reported as income and with the 9% net tax rate, the corporation will be paying $12,542 in taxes. That’s almost three times less than the taxes paid as an individual.
Now, imagine you have a really good year and your investments return $500,000 (the maximum amount for the tax credit). As an individual, you would pay $125,000 in taxes compared to $45,000 as a CCPC. The difference is day and night.
With a CCPC, money can be withdrawn through dividend payments which (unfortunately) will be taxed as income. Luckily for you, however, dividends can be withdrawn on a per-need basis, which means you only pay income tax on what you withdraw. This is similar to an RRSP, except a CCPC offers more flexibility, as you can withdraw money at any point without paying an early withdrawal penalty.
For investors that have maxed out their RRSP and TFSA contributions, the creation of a CCPC is the way to go. By creating a CCPC, investors can save thousands of dollars each year in taxes.
In the years that you don’t want to withdraw money, the capital gains can remain in the corporation, which means you will be paying $0 in income tax from capital gains.
When you’re ready to receive payments in the form of dividends, it will be taxed at the personal income tax rate, which is comparable to the RRSP. With a CCPC, however, you have the added flexibility of no contribution limit coupled with no early withdrawal penalty.
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Fool contributor Chen Liu has no position in any of the stocks mentioned. Tom Gardner owns shares of Shopify. The Motley Fool owns shares of Shopify and Shopify. Shopify is a recommendation of Stock Advisor Canada.
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