How to prepare for future changes in tax policy—including capital gains tax

Within the past year, for example, announcements from the Department of Finance resulted in last-minute changes to the reporting requirements for the underused housing tax (UHT) and bare trust tax returns. UHT reporting was significantly reduced for Canadian residents, trusts, partnerships and corporations, and bare trust tax return filing now will not be required unless the Canada Revenue Agency (CRA) makes a direct request to a taxpayer.

Given how these adjustments were late to be implemented and communicated to the public, many Canadians are wondering what will come of the new capital gains rules proposed in budget 2024.

Capital gains were left out of the government’s initial budget bill, introduced in May. Finance Minister Chrystia Freeland tabled a notice of ways and means motion on June 10, and a vote that would formalize the rules is expected this week. But, with Parliament soon breaking for the summer, the capital gains rules may not officially pass into law until the fall.

With so much uncertainty around capital gains, how should Canadians prepare for the tax consequences?

What’s changing about capital gains in Canada

The 2024 federal budget proposed an increase to the capital gains inclusion rate—the portion of a capital gain that is included in a taxpayer’s income—from one-half to two-thirds in some instances. As before, assets held in tax-deferred and tax-free accounts like registered retirement savings plans (RRSPs) and tax-free savings accounts (TFSAs) will continue to be excluded from capital gains tax. So, the inclusion rate changes apply only to taxable investment accounts and capital assets like a vacation property.

Impacted taxpayers include:

• Individuals with over $250,000 of capital gains in a tax year (only on the amount in excess of $250,000)
• Corporations
• Trusts

The individual taxpayers who are most impacted are those with assets like a cottage, rental property or business, since these assets must generally be sold all at once. Investors who own stocks, mutual funds or exchange-traded funds (ETFs) can sell investments incrementally to avoid exceeding the threshold.

Lessons on tax planning for business owners

Under the new rules, business owners selling qualified farm or fishing property or qualified small business corporation shares can utilize the proposed $1,250,000 lifetime capital gains exemption to mitigate the impact of the higher inclusion rate. There is also a new Canadian entrepreneurs’ incentive that may provide up to $2 million of additional tax-free capital gains by Jan. 1, 2034, as the incentive will be rolled out in $200,000 increments annually over 10 years starting in 2025.

This is not the first time taxpayers with corporations have experienced tax changes. In 2018, the introduction of tax on split income significantly reduced the ability to split dividend income amongst family members. This led to tax increases for some families who had become accustomed to sprinkling dividends amongst multiple family members to pay less combined tax.

The changes to corporate tax in recent years have made it more compelling for incorporated business owners to consider withdrawing money from their corporations instead of accumulating it. Corporate tax rates are generally 9% to 12.2% for small-business owners, depending on their province or territory of residence.

This tax deferral opportunity compared to paying out a salary or dividends to an owner-manager is compelling. But the higher tax rate on corporate capital gains tilts things even more in favour of taking extra corporate withdrawals to contribute to personal investment accounts like RRSPs and TFSAs.

Should you trigger capital gains tax before June 25?

If a corporation has deferred capital gains on appreciated investments it intends to sell within the next five to 10 years, it may be better off triggering capital gains prior to the proposed deadline. The dollar amount of income tax payable to sell investments after June 25 will be about 33% higher than before June 25.

It bears mentioning that the budget stated that the higher capital gains inclusion rate would apply to dispositions that occur on or after June 25.

On May 27, 2024, Canadian and U.S. securities markets moved to a so-called T+1 (trade date plus one business day) settlement time. As such, a trade would need to settle by June 24, and this likely means having to sell by Friday, June 21 to qualify for the lower capital gains inclusion rate.

What other tax changes may the future hold for Canadians?

These recent tax changes may have taxpayers wondering what else is coming. The truth is we simply don’t know. But if I had to pick one thing married or common-law Canadians could proactively consider to protect themselves from potential higher taxes in retirement, it would be to contribute to a spousal RRSP.

If you have a big difference in your RRSP balance or pension income relative to your spouse, the spouse with more assets or income can contribute to a spousal RRSP owned by the other spouse. The contributor gets the tax deduction, and the contributions reduce their RRSP room. The spousal RRSP account holder can take the future withdrawals.

Since 2007, retirees aged 55 and older with pension income, and those aged 65 or older taking registered retirement income fund (RRIF) withdrawals, have been able to split their eligible pension income. This can move income from a higher-income spouse to a lower-income spouse, saving tax. Could that ability change in the future? Who knows. But spousal RRSPs are one way to mitigate that risk.

If I had to speculate about other changes, I could imagine the introduction of income-based TFSA contribution limits. The U.S.-equivalent of the TFSA, the Roth IRA, has limits based on a taxpayer’s income; over a certain income threshold, high-income earners can’t contribute.

The capital gains tax exemption for a principal residence could also be at risk. In the U.S., only $250,000 of capital gains from the sale of your home ($500,000 for couples) can be sheltered from tax. Given our housing affordability issues in Canada, one could imagine that concept gaining traction north of the border.

Hedging against uncertainty

I think the best thing you can do is plan based on what you know today and avoid speculating about future policy changes. I am a fan of income smoothing in retirement and trying to use low tax brackets when available. This can reduce the risk posed by higher tax rates in the future or the estate tax implications of dying at a young age with large tax-deferred assets.

Capital gains changes have been talked about since the 2016 federal budget (the first under Prime Minister Justin Trudeau), and now taxpayers have very little time to plan before June 25. But had people taken steps in any of the previous eight years, they may have made poor choices or accelerated tax they did not otherwise need to pay. So, taxpayer beware!

Read more about taxes in Canada:

• How much is capital gains tax in Canada?—and other reader questions answered
• How it works: Capital gains tax on the sale of a property
• Should you max out your RRSP before converting it to a RRIF?
• Federal Budget 2024: How it will affect Canadians’ finances and taxes

About Jason Heath, CFP

Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto. He does not sell any financial products whatsoever.

Linkedin Twitter Facebook Website