The $50,000 Passive Income Rule: What Ontario Business Owners Should Know

The small business deduction, in one paragraph

A Canadian-controlled private corporation pays a reduced rate on its first $500,000 of active business income each year. In Ontario, the combined federal and provincial small business rate is 12.2%, compared with 26.5% on income above that limit. That gap is why most owner-managed companies care about keeping access to the full $500,000.

How passive income shrinks it

Federally, the $500,000 business limit is reduced by $5 for every $1 of passive investment income above $50,000. The measure, called adjusted aggregate investment income, is based on the previous tax year and combines all associated corporations, so a holding company's portfolio counts against its operating company.

• At $50,000 of passive income or less, there's no reduction.
• At $100,000, the federal business limit falls by $250,000.
• At $150,000 or more, the federal business limit is gone.

Ontario has not adopted this reduction for its own small business rate. So for an Ontario corporation, the extra cost shows up on the federal side: income that loses the small business deduction is taxed federally at 15% instead of 9%.

Part of that extra tax can come back later: income taxed at the general rate lets the corporation pay eligible dividends, which are taxed more lightly in your hands. The true cost depends on how and when money leaves the corporation, which is a question for your accountant.

What counts as passive income

Broadly, investment income the corporation earns that doesn't come from its active business, including:

• Interest and most rental income
• Dividends from portfolio investments
• The taxable half of capital gains on investments, when they are realized
• Foreign investment income

Some things don't count: capital gains on assets used in the active business, dividends from connected corporations, and growth inside an exempt life insurance policy.

Ways owners manage it

None of these is right for everyone, and each has its own trade-offs. They are worth discussing with your accountant once passive income starts approaching $50,000.

• Investment mix. Unrealized growth isn't counted, and only half of a realized capital gain is. Portfolios built for deferred growth tend to generate less passive income each year than interest-heavy ones.
• Corporate-owned life insurance. Growth inside an exempt policy isn't taxed annually and isn't counted as passive income. See our corporate-owned life insurance guide.
• An Individual Pension Plan. Contributions are generally deductible and move money out of the corporation's investment account into a pension. See our IPP guide.
• Paying more out. Salary or dividends reduce the corporation's investments, at the cost of personal tax today.
• Timing. Because the test uses last year's income, when gains are realized can matter.

Where to start

Ask your accountant what your corporation's passive income was last year and what it's likely to be this year. If the answer is close to $50,000, or above it, it's a good time for a joint conversation about which options fit. We can model the insurance and pension side and share the numbers with your accountant for review.