What is a “super tax”? It’s the term that has emerged in the media after the Ontario government introduced a new 2% tax bracket for income earned in excess of $500,000.
Quite obviously, this will affect a very small percentage of the population – less than 1%. For those affected, however, it places them within a hair’s breadth of a 50% marginal tax bracket. For some, it could be the proverbial straw that breaks the camel’s back in terms of undertaking strategic tax planning, particularly owners of small-business corporations.
So what does the arithmetic look like?
Approaching a 50% tax bracket
The new tax has been promoted as 2%, but that’s not the whole story. Ontario has a two-stage surtax that kicks in well before reaching top tax-bracket levels. A surtax is a tax on a tax. In 2012, a 20% surtax applies once provincial tax tops $4,213, with a further 36% surtax on provincial tax over $5,392. This works out to a combined 56% surtax on income in excess of $80,963.
For the top federal tax bracket on income over $132,406, the federal rate is 29%, the basic Ontario rate is 11.16% and the provincial surtax is 6.25%, for a total of 46.41%. If you multiply the new 2% tax by 1.56 for the surtaxes, it adds 3.12%, for a total of 49.53% on income over $500,000.
To ease the transition, the new tax will apply for only half the year in 2012, beginning on July 1. Breaking it down by income type, here are the marginal tax rates for Ontarions with incomes over half a million dollars:
Shareholders of business corporations
While this new tax applies to individuals, it could have implications for an owner-shareholder earning income through a small-business corporation.
Once one applies the gross-up and tax-credit procedure, the impact on Canadian dividend income is about 50% higher compared to salaried income. Looking at the table, after 2012 the top rate on salary will increase by 3.12% as detailed above, versus 3.90% and 4.30% for eligible and ineligible dividends, respectively. (For 2012, halve all those figures.)
Remembering that the new tax is only applicable to personal income over $500,000, it’s difficult to say whether this will be sufficient to motivate a business owner to adjust compensation structure, but it remains food for thought.
Note: A detailed rundown of corporate–personal tax integration in all provinces is available through our InfoCard of the same name, which is updated in August each year. Despite this Ontario development, our model will continue to reflect income at the top federal tax-bracket level as it is applicable to the bulk of business owners.
Ontarions not alone
In the fall of 2010, Nova Scotia introduced a 21% provincial tax rate on income in excess of $150,000. Combined with the 29% top federal rate, that makes for an official top tax bracket of 50%. Concurrently, the province suspended its 10% surtax. Ironically, this has meant lower net taxes for those with incomes up to about $170,000.
For Ontarions, this new tax has a political sunset once the province returns to a balanced budget, projected to occur about 2017. In the meanwhile, the simplest of tax planning may be to simply defer income recognition, which in the investment-income space would mean a preference toward holdings that generate unrealized capital gains.