In February, this column discussed how an “employees profit sharing plan” (EPSP), as defined in the Income Tax Act can be used to align employee motivations with maximizing a corporation’s business profits (i.e., the greater the corporation’s business profits, the higher the employees’ EPSP payment benefits).
That column also discussed some of the mechanics of forming and using an EPSP.
This column focuses on some of the tax benefits from using an EPSP.
One potential tax benefit from the use of an EPSP is that, unlike salary or bonus payments to employees, neither contributions by a corporation to an EPSP trust nor allocations by an EPSP trustee to employees is subject to income tax withholdings.
This provides income tax deferral opportunities for employees, including the business’s owner-manager.
To illustrate, suppose a corporation with a taxation year ending Dec. 31, 2008, wishes to pay its key employees a bonus of $100,000. It could accrue the payment in its 2008 year-end financial statements and tax filings.
For the bonus to be deductible for that taxation year, the bonus must be paid within 179 days after year-end, in this case before June 27, 2009.
The corporation’s remittance obligations will require it to remit withholding tax on the bonus upon payment of it in the first half of 2009.
The amount of this withholding tax would be 39 per cent of $100,000, or $39,000, assuming the key employees are taxed at the highest marginal rate in Alberta.
On the other hand, if the corporation establishes an EPSP and makes a $100,000 contribution to the EPSP trust between Jan. 1, 2009, and April 29, 2009, the contribution will be deductible in the corporation’s Dec. 31, 2008, taxation year.
The $100,000 contribution received by the EPSP trust must be allocated to employee beneficiaries in 2009 (i.e., between Jan. 1, 2009, and Dec. 31, 2009).
The employee beneficiaries would report the allocation as employment income in their 2009 personal income tax returns and pay combined federal and Alberta income tax of approximately $39,000 by April 30, 2010.
ºHence, the opportunity for an income tax deferral.
Another potential tax benefit from the use of an EPSP is that no Canada Pension Plan (CPP) or Employment Insurance (EI) withholdings appear to be required on either the contribution to the EPSP trust by the corporation or the allocation by the EPSP trustee to the employee beneficiary.
Accordingly, in the case of CPP, as the maximum annual employer and employee contribution for CPP in 2009 is $2,118.60 (or $4,237.20 in the aggregate), a corporate employer and its employee may not be subject to this annual cost through the use of an EPSP.
Of course, the use of an EPSP in this case may compromise or reduce the employee beneficiaries’ abilities to receive benefits from CPP and EI (if applicable) in the future, although the business owner could elect to invest those savings in his or her own personal retirement planning.
Thus, if the business owner-manager and his or her spouse are employees of the corporation, the potential savings from the elimination of the cost of CPP for them alone can be greater than $7,000 (net of benefits for employee’s tax credits for his or her CPP payments), on an annual basis.
As a result of these savings opportunities, some business owners have used an EPSP as the primary source of remuneration from their corporations.
There has been at least one Tax Court of Canada decision upholding this type of tax planning by a business owner.
Other tax benefits, beyond the scope of this article, also may be available from the use of an EPSP.
In view of the inherent flexibility of an EPSP and potential business and tax benefits from the use thereof, consideration should be given to utilizing an EPSP in business and tax planning for a corporation and the business owner.
Tax Talk appears on the first and third Tuesday of every month in the Business Section of the Advocate. It is written by Jason Stephan, a chartered accountant and a tax lawyer who is tax counsel with Red Deer law firm Warren Sinclair LLP. Readers with specific tax issues are encouraged to consult a qualified tax professional for advice appropriate for their circumstances. Stephan can be contacted by email at firstname.lastname@example.org and by telephone at 403-343-3320.