How Is Passive Income Taxed in Canada

What is passive income? And how can we get some of it, at least temporarily?

Passive income is money that you earn without having to do anything to generate it. This could be via an online business or website that generates revenue for you, through investments or properties that produce rent, or even through experiences (such as taking courses or traveling) that don’t yield direct returns but give you pleasure.

The great thing about this type of income is that you doesn’t have to work hard to keep it. You just need to let things come to you naturally, consistently and without too much effort.

There are two main types of passive incomes: those that are taxable and those that aren’t.

Taxable passive income comes when your earnings are categorized as “salary” or “rent” and therefore taxed accordingly. Examples include dividend payments and rental income.

However, not all sources of income are considered safe tax-free zones. Certain activities may be construed as working, so they’re offset by their costs. For example, if you take lessons then you're spending money on training — this isn't pure leisure.

In fact, one of the most common ways to lose track of what constitutes active vs. passive income is buying a boat.

Capital gains are also taxed

how is passive income taxed in canada

In addition to income tax, Canadians pay an additional tax called capital gains or stock market profit taxes. These can be confusing because there is no general definition of what constitutes a capital gain.

A capital gain happens when you sell a larger asset (such as a house) for more than you paid for it. The difference between the sale price and acquisition cost is your capital gain.

Some examples may make this clearer. Suppose I buy a car for $5,000 with cash. One year later, the car’s manufacturer offers a special promotion that makes the vehicle free for two years for every seller they recruit.

I quickly put out my hand and take advantage of this offer so I can get some use out of my new car. Because I received the car free, the manufacturer lists my purchase price as “cost” not “acquisition cost.” This means I didn’t have to include the cost of the car in my taxable income.

My taxable capital gain was then calculated by taking the sales price of my car ($0 due to the free 2-year warranty) minus its cost of $5,000. That leaves a total capital loss of $4,500 which cannot be carried forward to future years.

Paying tax is a requirement for receiving some government benefits

how is passive income taxed in canada

As we mentioned before, being able to pay your bills and live a good quality life depends largely upon how much money you make. If you are making a large income, then you should be conscious of how this looks to others – you probably want to make sure that you are paying your taxes and staying within the law.

Most wealthy people are not well known for their charitable contributions or acts of generosity, but they do not need to be. What most rich people don’t tell the public is that they also enjoy paid vacations, health insurance, free food, and other benefits that help them lead a comfortable existence.

These benefits are not granted to everyone, of course- only to those who earn enough money to purchase them. It is important to note though that even if you are struggling to make ends meet, it is still possible to contribute to all these things through giving up some of your passive income.

Capital gains are taxed at a lower rate than regular income

how is passive income taxed in canada

When you sell an asset, like a house or car, we call it a capital gain. This is because you’re losing this asset, so your wealth has decreased as well as its price.

When you eventually sell an asset, what kind of tax you pay depends on two things: how much profit you make (capitalism!), and whether that profit is considered ordinary income or long term capital gain (the difference being that one is taxed more lightly).

Capital gains are typically treated as ordinary income if the money is transferred to you directly from savings or another investment property. For example, if you earn $1 million after investing it for years, and spend half the year traveling with it, then return it and keep the other half, your taxable income would include both the $1 million salary and the $500,000 cost of the vehicle.

But if you rent out an apartment using revenue sharing or a triple net lease, only including your monthly rental income in your income, passive investors often use an IRREGULAR LOAN STRUCTURE TO SELL THEIR PROPERTY!

This means they withdraw their money before the end of the lease to reduce the amount of capital loss reported. A lot of people do not realize that even though this may be legal, it can still result in higher taxes.

Dividends are treated differently than capital gains

how is passive income taxed in canada

Dividend income is not taxed at all, instead it is credited to your personal savings account. As such, most people consider dividends as very expensive ways to earn money because you have to save every bit of dividend income you get!

Dividends can also be more lucrative than capital gain investment strategies due to the lower tax rate. The average Canadian pays higher taxes when they include their marginal rates (the additional taxable income that gets you into the highest tax bracket) when investing in stocks through capital gains.

By contrast, individuals who invest in dividend paying securities pay only the basic or exempt level of taxation per year. This means that even though their income is increased due to the stock market rise, they still owe less tax per year than if they invested in companies with capital gain potential.

Furthermore, since we’re talking about investments here, there are many different types of accounts and classes of shares available. Some will keep your financial information private while others offer more security. There is no one right way to manage your finances, but depending on what type of investor you want to be, you should know how different features suit you.

Self-employment is more heavily taxed than working for a company

As mentioned earlier, self-employed individuals are taxed at a higher tax rate than employees. This can be confusing as there are two different types of income that make up your total annual income. Active business owners typically report their business profits on their personal taxes as business revenue or income.

However, most people who choose to work independently do not have an employer they pay payroll taxes through, which are additional taxes paid on employee benefits such as health insurance. These extra employment costs are what really add up in the long run.

Furthermore, many self-employed individuals also claim certain expenses like professional use of home services or software as deductions instead of including them as monthly bills. By claiming these things as deductions, you reduce how much money you include when calculating taxable income.

This article will go into greater detail about passive income and why it is important to understand how taxation works.

Some sources of income are taxed at a higher rate than others

how is passive income taxed in canada

As mentioned earlier, all forms of income is taxable depending on what it’s classified as under tax law. This includes interest, capital gains (the profit you make when you sell an asset) and dividend income.

Most people pay lower personal taxes by considering only the rich earn significant dividends and/or capital gain income. However, this isn’t always the case!

In fact, some individuals enjoy high levels of dividend income or large capital gains that can net them a very substantial tax refund every year.

Dividend income happens when a company pays out a proportion of its earnings to shareholders. For example, if General Motors paid out $1 billion in dividends last year, each shareholder received $100 thousand per year for owning one share of GM stock.

This is considered passive income since the money is automatically deposited into your account without you having to do anything to get it. In addition to receiving a dividend payment, investors also often times receive additional ‘dividend gifts’ such as extra shares or a choice of stocks from GM.

Capital gains occur when you sell an asset (like a house) for more than you bought it for. So, instead of paying a regular income tax on the difference between the sale price and the original cost, you qualify for a capital gain where part of your income comes directly from the increase in value.

Some tips for paying less tax

how is passive income taxed in canada

Being able to afford your monthly payments, or even not having debt at all is one of the best ways to avoid high taxes. But before you get too excited about that, there are some strategies you can use to pay lower income tax in Canada.

Many people have made it their life’s mission to understand how to reduce their personal income tax bills as much as possible.

Fortunately, most Canadians don’t actively pursue this goal, but those who do may be surprised by what they find.

Here we will go through five simple strategies to help you keep more money in your wallet come April 15.

Removing excess debt is a great way to start investing in yourself and improving your financial situation.

Not only does reducing debt free you from large obligations, it also gives you extra cash to put towards more important things like education, savings, or starting a business.

1) Reduce Your Annual Expenses

This is probably the easiest way to save on income tax. Simply cut back on annual expenses (not weekly ones!) so that you spend the same amount every year on non-taxpaying activities.

For example, if your lifestyle includes eating out twice a week, then try going once a week to see if you can survive. If not, drop the other day and save some cash!

Likewise, if you enjoy drinking alcohol, consider cutting down on how many drinks you consume.

Creating your own business

how is passive income taxed in canada

Let’s say you want to start your own fashion line or restaurant, or whatever other business idea you have. Unfortunately, starting your own business is not as simple as some might make it out to be!

There are lots of costs involved in doing this, not the least of which are legal fees. Starting your own business means dealing with the government and tax agencies on a regular basis – so prepare yourself for that!

In fact, according to Mandy McQueen, CEO of Can-Do Resources, one of the most common ways new entrepreneurs get into debt is paying too much attention to taxes. It's easy to assume that because you're using profits or income to fund your business, then you don't need to pay as many bills, but that can backfire.

"Most small businesses fail within first year due to lack of funding," she says, "so spend time investing in your business, but also invest in family and friends who can help you along the way."

Business owners often fall victim to their expenses coming in faster than their money going out, particularly during the early stages when things aren’t running smoothly yet. This can easily end up putting stress on them.

McQueen recommends every entrepreneur do an analysis of how much they owe relative to what they earn before adding more to the mix.

About The Author

Tiara Ogabang
Tiara Joan Ogabang is a talented content writer and marketing expert, currently working for the innovative company juice.ai. With a passion for writing and a keen eye for detail, Tiara has quickly become an integral part of the team, helping to drive engagement and build brand awareness through her creative and engaging content.
Juice Beta is ending July 1st! Subscribe before end of month to lock in Juice Plus for 50% off!
$49 $25
Sign up now
Juice Beta is ending soon! Subscribe now to lock in Juice Plus for $49 $25
Sign up now
cross