George is a friend of our family. He’s 77 years old and he’s a little hard of hearing. Last weekend, I was asking him what he thought of clawbacks. You know, the government will claw back some of the benefits it pays when your income is above certain thresholds. George went on at length about how much he has enjoyed this over the years. “There’s nothing more satisfying than relaxing by the water with my wife, some clams, potato salad and a cold one, enjoying the sunset.” It turns out that George thought I said “clam bake,” not “clawback.”
Just as I suspected, clawbacks were not something he enjoyed with potato salad, a cold one, or any other manner of food. On the contrary, he was frustrated by this additional “tax” that the government applied to him. If you’re subject to a clawback of any government benefits, particularly Old Age Security (OAS) benefits, read on.
If you’re collecting OAS benefits and are earning more than $70,954 in 2013, you will find yourself sending all or part of your OAS benefits back to the taxman. The clawback is equal to 15 per cent of any income over $70,954 this year, so your full OAS benefits will have to be repaid once your income is $114,640.
While it’s true that someone with that level of income could be in reasonable financial shape, it’s also true that seniors often face unexpected and significant costs, particularly for long-term care if that becomes necessary, and very few have planned for this. In addition, there is a school of thought that leaving those dollars in the hands of seniors to spend or reinvest would do more to help the economy than handing those dollars back to the taxman. And so, the quest to minimize the clawback continues, and I’ve got an idea to share.
Consider George again. George earns interest income on $800,000 of investments and has income from his registered retirement income fund (RRIF). His OAS benefits are largely clawed back. George can reduce the clawback by moving some of his investments into a tax-free savings account (TFSA), but this would not be sufficient to eliminate the problem.
George can also use a corporation to help reduce or eliminate his clawback. How? He can transfer his non-registered investments ($800,000 in his case) to a newly established holding company (this can be done at no tax cost today). In return, the company would owe George $800,000. This loan to his corporation would not bear interest, and there would be no fixed terms of repayment. The corporation would now invest the money and pay tax each year on the income earned. Since George would not be earning this income personally, he would escape the clawback of his OAS benefits.
But we’re not done. Each year, George’s company can declare a dividend to him equal to the full amount of the after-tax earnings of the company. The dividend would be payable to George but would not actually be paid to him each year. If the dividend isn’t paid to George in cash, how does he get his money out of the company to cover his costs of living? Simple. The company can pay this cash to George each year as a tax-free repayment of his $800,000 loan to the company. Eventually, the loan would be paid off, at which time the company would start to make good on the dividends payable to George, but this may not be for several years.
At the time of George’s death, his heirs would become the owners of his holding company. At that time, the investments can be distributed from the company to his estate in the form of dividends that were payable to George during his lifetime. This would save tax because these dividends would be considered a “right or thing” and George’s executor would be entitled to file a separate tax return for this amount. This would multiply certain personal tax credits since these credits can be claimed on potentially more than one tax return that is filed after death.
Finally, the value of the company’s shares at the time of George’s death would probably have a nominal value because of the dividend liability owing by the company. This would reduce the tax owing on those company shares at the time of George’s death.
The idea of a corporation for this purpose has even more appeal if you can use the company for other purposes as well, such as reducing U.S. estate tax on U.S. investments, and minimizing probate fees on the assets inside the corporation. Speak to a tax professional about the pros and cons.Report Typo/Error