Many people in Canada are interested in reducing their tax obligations and identifying the exemptions that can provide significant savings. Good tax planning involves understanding the exemptions you may qualify for and taking relevant actions to ensure that you remain qualified.
One such exemption is the Lifetime Capital Gains Exemption (LCGE), which shields some of the proceeds from the sale of a small business from tax. A tax lawyer can provide detailed advice and analysis as to whether you qualify for the LCGE or other exemption.
This article is a brief overview of the Lifetime Capital Gains Exemption (LCGE), and how it may provide protection for some small business owners or investors.
What Is the Lifetime Capital Gains Exemption (LCGE)?
The Lifetime Capital Gains Exemption or LCGE is an exemption from capital gains tax specifically for the disposition of shares of a qualified small business corporation. The LCGE is designed for individual taxpayers to protect their income from the sale of a qualified small business corporation share, farm or fishing property.
For 2021, the LCGE – which is a lifetime limit, not an annual limit – is $892,218. Up to $892,218 in capital gains from selling shares in a qualified small business corporation may be entirely sheltered from tax. Each year, this amount may be expected to increase incrementally, as it is tied to the Consumer Price Index to account for inflation. The Canada Revenue Agency provides a record of its pegged adjustments for the LCGE and other tax matters.
What is the capital gains tax?
The LCGE is specifically an exemption from capital gains tax, the type of tax assessed on the portion of your income obtained from selling capital assets, including stocks, bonds, cars, boats, land or real estate. In Canada, 50% of realized capital gains are taxable. That is, half of the profit or capital gains you earned will be calculated as part of your income and taxed at your marginal tax rate based on your overall income for the year, including your capital gains.
However, you can offset your capital gains tax with capital losses, when you sell an asset and lose money. All of your capital gains and losses can be calculated before applying them to your income for the year. In fact, you can carry forward capital losses indefinitely to offset future capital gains, or you can carry them back to the prior three tax years to offset past payments of capital gains tax.
The formula to calculate capital gains tax is:
Capital gains – capital losses = annual realized capital gains
(Annual realized capital gains x .50) x your marginal tax rate = capital gains tax due.
However, this is just one way of limiting your exposure to capital gains taxes. The LCGE is another key option, especially for entrepreneurs, investors and business owners.
What qualifies for the LCGE?
The LCGE is generally available only available to individuals, not corporations. You must be a resident of Canada for the entire tax year in which you intend to claim the exemption.
The shares you sold must have been part of a qualified small business corporation. In order to qualify, the following rules apply.
- The shares must be of a small business corporation, a Canadian-controlled private corporation that uses at least 90% of its assets in active business in Canada at the time of the sale.
- No one other than you, a relative of yours or a partnership of which you are a member may have owned the qualified shares for the 24 months before the sale.
- Throughout the 24 months before the sale of the share, it must have been a share of a Canadian-controlled private corporation using at least 50% of its assets in Canada in active business.
A holding corporation may qualify if it has over 90% of its investments in a qualified small business corporation or if it owns shares in a qualified small business corporation.
- At the time of the share sale, over 90% of the assets of the holding company must be involved in active business in Canada.
- For the 24 months before the sale, more than 50% of its assets must have been engaged in active business in Canada.
- The shares must have been owned by the holding corporation for the 24 months before the sale.
You can only qualify for the LCGE if the small business shares involved meet these criteria, including the 90% and 50% thresholds for active business in Canada. A tax lawyer may work with a small business corporation to prepare for share sales that qualify for the LCGE.
To ensure that you and your small business are taking advantage of relevant tax laws and exemptions, our tax law firm can help answer your questions and provide detailed advice specific to your situation.
Contact Sabbagh & Associé to discuss the Lifetime Capital Gains exemption specifically or for any other tax law related concerns.
NOTE: This article does not constitute legal advice from or legal opinion. It is only used to inform readers about certain aspects of tax law.