Episode 155: The Hidden Cost of Passive Income (And How to Fix It): A Canadian Business Owner Case Study

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Are your passive income investments growing your wealth—or growing your tax bill?

It’s easy to think that getting started is the hardest part of building wealth. But what happens after you’ve begun? For many investors—especially Canadian business owners balancing personal and corporate assets—the next steps are the most financially impactful. How do you structure passive income investments to reduce tax drag? Where should your dollars be working to protect and grow your wealth most efficiently? This episode dives into the advanced strategy zone, where structure matters just as much as substance.

You’ll learn:

• Why simply earning more passive income isn’t enough—how to keep more of what you make by optimizing where you earn it.

• The real risks (and hidden opportunities) of generating passive income inside a corporation—and how to avoid the “grind-down” tax trap.

• How a single strategic swap between corporate and personal investing can unlock major long-term tax savings without increasing your risk.

If you’re a business owner ready to move from asset accumulation to tax-optimized wealth building, hit play now—this episode lays out the roadmap.

Resources:

• • Ready to take a deep dive and learn how to generate personal tax free cash flow from your corporation? Enroll in our FREE masterclass here. 
  • Book a Discovery Call with Kyle to review your corporate (or personal) wealth strategy to help you overcome your current struggle and take the next step in your Canadian Wealth Building Journey!
  • Discover which phase of wealth creation you are in. Take our quick assessment and you’ll receive a custom wealth-building pathway that matches your phase and learn our CRA compliant tax optimized strategies. Take that assessment here.
  • Dig into our Ultimate Investment Book List
  • Follow/Connect with us on social media for daily posts and conversations about business, finance, and investment on LinkedIn, Instagram, Facebook [Kyle’s Profile, Our Business Page], TikTok and TwitterX. 
    

Calling All Canadian Incorporated Business Owners & Investors:

Consider reaching out to Kyle if you’ve been…

• …taking a salary with a goal of stuffing RRSPs;
• …investing inside your corporation without a passive income tax minimization strategy;
• …letting a large sum of liquid assets sit in low interest earning savings accounts;
• …investing corporate dollars into GICs, dividend stocks/funds, or other investments attracting cordporate passive income taxes at greater than 50%; or,
• …wondering whether your current corporate wealth management strategy is optimal for your specific situation.

Are you investing in the right place—or just investing? Business owners and wealth builders often focus on picking the best asset classes or chasing higher returns, but the structure of your investments can make or break your long-term strategy. In this episode, we unpack how aligning your corporate assets, personal finance, and investment strategies can dramatically reduce tax implications, protect passive income, and accelerate wealth creation. You’ll learn how to optimize for financial independence, grow your net worth with smarter financial planning, and use capital gains, compound interest, and strategic asset allocation to build true financial security. If you’re navigating asset accumulation, retirement planning, or pursuing early retirement through the F.I.R.E. movement—this one’s for you. Hit play and start building wealth that lasts.

Transcript:

Jon Orr: Today we’re going to unpack an important idea around our investing and choices around our investment. And oftentimes, if you’ve listened to episodes before, we often talk about it doesn’t matter what you invest in. It matters how long you invest in that you invest in that. always say it’s about getting started and not letting analysis paralysis affect your choices. Now, however, today we are going to unpack some specific scenarios.

Specifically with the client who reached out to us through YouTube and has been watching us for a long time on our YouTube channel. And we unpacked their unique situation because even though we have said, you know, it doesn’t matter, it matters. It matters. So there’s two parts. know, it doesn’t matter that you start investing and you are choosing appropriate asset classes, is that you are investing, but it does matter in your situation, maybe which asset classes make the most impact over that long term for you. And that’s what we’re going to unpack here using this case from a client of ours who reached out through YouTube.

Kyle Pearce: Awesome, awesome. Yeah. And know, John, I had an awesome opportunity to chat with this individual has a lot of great things going on. And I also want to add to, you did a good job highlighting the idea between, you know, it’s almost like stages, right? As you had mentioned, it’s like, get investing in anything, get investing. Great. As you get investing, then you start to think about, okay, what should I be investing? Okay. And then as you start to recognize

You know what, I want some in this, I want some in that. Maybe you want some real estate, you want some stocks and bonds, maybe you want some commodities, maybe you want gold and silver, all of those things. Like you can figure that out as you go along the journey. But then once you figure that part out, we are now at a stage where you start thinking to yourself.

Where should I be investing in these things? So a good example here doesn’t apply to the client we were chatting with, but just to give it a nice example to frame this is that, you know, when I’m investing in my RRSP’s tax free savings account and unregistered accounts, which should I be investing in where that that can matter, right? Why can that matter? Well, guess what? If you’re not going to get taxed on anything in the tax free savings account, guess what? I’m open to earning quite a bit in terms of say capital gains or dividends or interest because it’s all going to happen tax free. Whereas if it’s in an unregistered account, I might think about doing things like capital gains only because then I’m not going to realize those capital gains until I sell. So there’s a lot of things that we need to be thinking about and it gets even more complex.

as you start incorporating real estate into the mix, incorporating for your business or your real estate portfolio, for example. And in this particular case, we want to kind of highlight a scenario where just simply deciding where to make specific investments can have a massive impact on…

the total net worth of this individual over the long term, but then obviously the amount of cashflow they’re gonna be able to create for themselves as well.

Jon Orr: Yeah, yeah, because I think it’s like, you know, when we talked about the act of getting started with investing is really about learning the behavior and the pattern of this is who I am, and I am an investor, and I do this is more important than say what initially, once you have established that pattern behavior, that this is what you do, then you start to move from phase one and a phase two and a phase three and a phase three is about now going, how am I protecting my

How am I protecting the hard earned capital and that’s when we start to optimize based off structure and Making sure that we you know, aren’t leaving money on the table Because we have that pattern in that behavior going so let’s get into the details Kyle. Give us give us a scenario here

Kyle Pearce: Yeah, so we’ve got a business owner. This business owner is married, has three children. They’re younger children. Looks like twins, because the two are both five years old. So twins and an eight-year-old. Sounds like, man, it sounds a lot like John. Yeah, I didn’t catch whether they’re all daughters or if there’s any sons in there. They are about 40 years old, this couple. OK?

Jon Orr: Sounds like us, yeah, yeah. Little younger, little younger.

Kyle Pearce: owns business, is doing well in business, and the spouse is working a T4 job, which again, it’s a great mix, right? So you’ve got some income coming into the household by force, we’ll call it, and then we’ve got other income that gets to be a little bit more controlled, right? He gets to decide. So he gets to decide to take salary or dividends or both, depending on what the household might need. They have a good amount of assets on both sides of the quote unquote

corporate border. So lots of good things going on. They own their primary residence and they have about I’m going to put it in the range of about $350,000 of equity that is available to them that they are intending and I’m going to say I think it’s more equity available but this is the amount that they are intending to put into investments via say Smith maneuver. Okay, so they’ve got Smith maneuver on the radar. When we look to the…

Jon Orr: They’re not started the Smith maneuver yet. They’re kind of like, is where I want to go.

Kyle Pearce: I think they have a small investment that they’ve made through some sort of private placement with some of the equity. So they have done some of it before, but it sounds like now they want to get into more of a routine around it. Okay. And I think that’s how they found us on YouTube. We’ve got, you know, many episodes, as you all know, listening or watching about the Smith maneuver in particular. And then they went down the rabbit hole of like, but what about on the corporate side of things as

You know, many people will know if you’re earning income actively inside the corporation, inside an operating company, you are getting a tax benefit of a low tax rate on the first $500,000 anywhere in Canada. Okay, you’re getting a tax benefit. It’s gonna be a slightly different rate depending on the province, but here in Ontario works out to about a total of 12.2 % on net operating income of any.

number below $500,000. This individual is also in Ontario. So they’re dealing with something like that. So what do we say? We say, listen, if you don’t need to take the money out for personal needs now, it’s great to kick the can and keep those dollars inside the corporation, keep them as whole as possible. And they’ve done a good job of doing so already. They’ve got about $800,000 inside the corporate structure.

that is, and actually more than that in retained earnings on the balance sheet, but about $800,000 that is split up amongst different assets, about 60 % in equities, commodities, know, silver and so forth. And then about 40 % split between cash, and actually they have a high cash value life insurance policy in there as well. So they have about 50,000 in cash there.

and about 160 or so thousand of cash value already in this policy. So a typical 60-40 split, we see this a lot with business owners, right? Business owners need liquidity, they don’t want to ever find themselves in a cash flow crunch, so a policy is a great fit to do that. So they’re doing a lot of these great things already. And the question that they came to us with was around…

investing and around their concerns around passive income that’s being generated in the corporation and their concern about the grind down rule. Okay. And the grind down rule for those who don’t know or unaware, the more passive income we generate inside a corporation, not only are we being taxed as if you’re in the highest tax bracket as an individual. So here in Ontario at about just north of 50%,

on every dollar of interest or dividend income or any other rental income, for example, it’s going to be painful on that front. But also, as we start growing more and more passive income each and every year, the government takes away how much of that small business tax credit you get. Meaning, basically they’re saying, listen, this was for small businesses.

And if you’re generating enough passive income each and every year, I guess you’re not that small of a business anymore, are you? Right? It means like you’re investing in passive income generating things. You are not focused on growing your operating business. And therefore we’re going to start, we’re going to start clawing back some of that cheap tax dollars. and here in Ontario, if it’s fully ground grinded away or ground away, I’m not exactly sure of the appropriate word for it.

you’ll all of a sudden be earning operating income at 12 or 26 and a half percent. So it’s a significant jump. You’re gonna pay more than double tax on the active income. So passive income is a real concern and deciding how you can ensure that you are essentially being smart about keeping your passive income low and…

doing other things to keep the money growing in your corporation in a tax incentivized way or a tax optimized way is a really important move.

Jon Orr: Sure. So it sounds like just a quick summary here. He had a 60-40 split inside the corporate structure. An ETF portfolio, commodities, we got a bunch of assets here that are growing in value and in a way giving us a little bit of passive income. And if we keep going in this strategy, that might have some tax say.

disadvantages moving forward. So he reached out to us to go like, what should I be doing now? When he reached out to us, Kyle, specifically, what was he thinking of doing? Like, what was his plan? Moving forward? Was it just to keep investing in like knowing that there’s a tax grant grind down rule is going to affect him? Was he was he like, what should I do? Or like completely like I have no idea or like, here’s what I think I should do. And you’re like, let’s go forward with that. Or like, actually, you should try this.

Kyle Pearce: Yeah, and actually I think I should backtrack here because I left out a key detail. Remember, there was a discrepancy between the investments of about 800,000 and his actual retained earnings on the balance sheet. And in my head, as I said it, I was like, where did that other money go? And it’s in private lending right now, okay? So he’s got money out in private lending. So he has sent money out.

And of course, when you’re doing private lending, are typically earning a favorable interest rate. Now we didn’t get into the nuance of exactly what the percentage was, but let’s pretend it’s around 10%. And that is considered passive income. So he is now approaching this challenge where his accountant is saying, you know, there’s a lot of passive income being generated at least to a point where it could become a challenge in the future.

Right, and as we mentioned, if you earn more than $50,000 in passive income, you are going to slowly grind away at your active income small business rate that you’ve been getting. So okay, so this is what he’s looking to try to essentially protect against. So now, the initial conversation started with the idea of going, you know what, I’m thinking about doing.

an immediate financing arrangement. We’ve discussed this on the podcast before. This is where we fund high early cash value life insurance and we immediately lever it. So right away we go to a usually an independent or a third party lender. It could be a big bank, it could be a private capital firm, it could be anyone. We say, listen, I’m putting this policy in place. I’m gonna put X number of dollars of premium out every year and here’s what the illustration looks like.

Can you give me 100 % of cash value on that? And typically they say yes. So in his mind he’s going, you know, if I do that, he’s already got a small policy that has grown to become relative, you know, an important amount, important size, about $160,000 of cash value that is corporate owned, but ongoing, that’s not gonna be enough for him to do an immediate financing arrangement and deal with this passive income because he’s got

an ETF portfolio. I said it was equities, but in reality, it’s still spitting off enough dividends that that’s a problem. And this private lending, which he wants to do more of, right? Once you get the taste of private lending and you see that cash coming in, you’re like, I want to do more of it until something goes wrong, of course, right? And that

Jon Orr: I see. So, so it’s. And that’s why he wanted the IFA? Is that why he wanted the IFA? Is like, just want access to some more capital to lend out. Okay.

Kyle Pearce: Exactly, and really in his mind, and he’s on the right path that he’s going, listen, if I borrow against the cash value of this policy, I can do it inside the corporation, and there’s of course gonna be interest on the loan against the policy, which the cash value loan that you’re taking. That can be written off against some of his passive income. he kind of gets,

three wins here, right? He’s going to get the policy that’s growing each and every year tax free, which is good. That’s awesome. It’s going to get the future death benefit that’s going to pay out through the capital dividend account to the estate tax free. Awesome. Amazing. And what he’s going to get is he’s able to reinvest those dollars, having his dollars invested in two places at once into a high, you know, a high interest earning, investment here and he’ll be able to essentially offset some of the costs that he’ll pay in tax by simply writing off the interest on the loan against the interest he earns on the private lending. So on the right path, but imagine if there was a world where maybe we can do this even better.

Jon Orr: Well, so what do mean saying even better? like what’s wrong with the move? Nothing is wrong with the move. It’s just like, you’re not fully optimizing and making use of all of the options available to you between your corporate life and your personal life. Is that what you’re saying?

Kyle Pearce: Exactly. That’s exactly it. Because what he has going on is in his mind, right? As we mentioned, there’s more than just this thinking going on. And every time we hop on with a client, we look at their full picture, right? And I usually draw really, you know, crazy looking pictures. And I try to show, you know, your personal side, your corporate side. And of course it’s at a very high level. But if you recall earlier in the conversation,

he was planning to do some Smith maneuver maneuvering on a personal level. And I then started digging in and saying like, so what’s the plan over there? And you know, and to be honest, this client at first, I think was sort of like, you know, he’s kind of like me is a fact finder. He’s like, I want to know about this thing. And he wanted to focus just on this thing. And I really kept pushing to say, what are you going to be planning to invest in on the other side?

because it matters. And why it matters is let’s pretend we put an IFA in position. you know, Max funded a policy, we got a bigger policy going so that he can do this. He can go all in on private lending. He’s gonna be way further ahead than if he just took all of his retained earnings and put it into private lending. And then the grind down rule takes over. Now he’s paying more tax on active income. He’s paying 50 % on the interest he’s earning in private lending.

Not a good situation. So just by doing the IFA on its own, just plain Jane, he’s going to be well ahead. That’s a good thing. So we’re already better. But if we can make this even better, if we can go to the next level and go, let’s optimize because remember this isn’t just a company. This is you personally as well. This is your family. This is all of the other assets that you have. And at the end of the day,

It all comes out in the wash as to who owns it. It’s you and your spouse that own all of these things. So imagine that we can be a little smarter about where we earn income so that we can take advantage and have more control over the tax that we might pay. That’s where we wanna get our heads going. So while I’m gonna still be in favor of an IFA, what I wanted to know from him is what do you plan to invest in with

the Smith maneuver and what he came back to me with was a very I’ll call it you know, we’ll call it a typical asset mix portfolio having equities and fixed income on the personal side. And that’s when I said, you know, based on that, it sounded like to he was trying to be a little bit more conservative in terms of what you know what he was aiming to achieve or what he was aiming to do.

and on the personal side. And that’s because he’s lending again or borrowing against his personal or primary residence. And what we started to discuss is how, if he was going to instead do what investing he was going to do with the Smith maneuver in the corporation and focusing more on capital gain like equity assets and take that private lending and actually do it at a personal level.

What he’s able to do, he’s still gonna get an interest write-off in both scenarios. The IFA is gonna generate an interest write-off, why? Because it’s an investment loan. The same is true when he borrows against his primary residence, he’s gonna borrow, and because it’s an investment loan, he can write off the interest there. The difference is, if I can earn that private lending income at a personal level, I get to claim it at my personal tax bracket.

instead of the passive income tax bracket inside the corporation, I now have full control. And why I say full control is because remember, he’s a business owner. So he doesn’t have a forced T4 that he has to take. He can design this such that maybe a good chunk of his personal income is going to come from private lending. And therefore, he actually doesn’t have to take as much of a salary or dividend at a personal level. He gets to keep more money

in the corporation to growing compound in there and he’s able to take a much lower tax payment or tax due or owing on that 10 or 12 % interest that he’s been paying at passive income tax rates inside the corporation.

Jon Orr: Did you discuss because that makes a lot of sense. Like you’re you’re trying to optimize the tax, you know, which tax you’re to pay at which level. And and if we’ve got a lower level of personal, then we would be getting at the for passive income at the corporate level. Let’s try to transition or shift one asset from one asset strategy from one bucket to another to take advantage of that. Did you discuss shifting, say, the that

you know, more of the what he was planning to do with with say, investing with the Smith maneuver on the personal side into the corporate side. Like was it like, let’s put those assets inside there. And therefore, are we still are we still, you know, are they they still passive income sourced and we’re not, you know, eliminating that issue? Or are we actually solving for that issue over there? Because now they’re saying they’re not dividend paying, you know, assets that really are accumulating you know, passive income anyway.

Kyle Pearce: Yeah, well, the beauty is so if we can take as much of the passive income generating assets and have them invested at a personal level. So if he’s taking them out over here and he’s earning say 12 % over here, whatever he’s going to pay in tax is going to be dependent on his own tax bracket, which again, he gets to control here so he can choose to take no income from his corporation and therefore whatever he generates on this investment, right is is going to be what’s coming to him now.

at 10 or 12 % a year on say $300,000, like we’re only talking about 30 to $36,000 of income. That may not be enough for him. So he might still need to take some money out of the corporation via dividend or a salary. I’m gonna recommend a small salary is probably the way to go there. But the beauty is, that that might keep his tax rate. If let’s say all he earned was the $36,000 off of this, he’s gonna pay a very low rate. He’s gonna pay like,

below 20 % on that amount, probably closer to 15 % where he is on that amount instead of 50 % on that 12 % over here. Plus he’s gonna get a write off against the interest here. Now, has he completely eliminated tax at all in the corporation? The answer is no, it’s not that he’s completely eliminated tax, but he has more option. And when he goes and he decides to fund his policy, which

he is then aiming to put into instead now, he’s going to instead of the stock portfolio he was going to invest in here, he can do that over here.

Jon Orr: If you’re meeting like you’re referencing inside the corporation.

Kyle Pearce: inside the corporation. Yes, and actually, sorry, my friends who are listening right now, I’m drawing on the screen. So those who are on YouTube with us, just type in IFA or type in private lending. We’ll put in some keywords there so it pops up and you can hop into this video for Canadian Well Secrets. But over here, I’ve got a big, big box which represents his corporation. And really what we’re gonna do is we’re going to over time take retained earnings.

Jon Orr: It looks like you’re trying to draw something when no one can hear you.

Kyle Pearce: And we’re gonna try to get, I’m gonna say as much as you want to get into a policy. For me, it’s as much as I can get in. And the reason why is because I know eventually these retained earnings are gonna be taxed at a personal level by someone, me, my spouse, my kids, a charity, someone. So I’d rather get it to touch a policy, growing compound tax-free and be able to pay the net death benefit tax-free out through the capital dividend account. So right there, you’re gonna get a,

a state value that’s gonna be way, way better over time. every year it’s gonna get better and better. He’s now gonna invest in the stock portfolio that he originally was going to invest in with the Smith maneuver on his primary residence. He’s instead gonna do that in the corporation. So I wanna pause here for a second. The risk has remained exactly the same. All we’ve done is we’ve just swapped where we’re gonna make these investments. So I’m not telling him to change

what he invests in, he gets to choose what the right fit is for him. And I’m in full support of that. And here all we’re doing is we’re flip-flopping where it happens. So some people go, I’m kind of nervous lending against my primary residence in order to earn this high 12 % return. You were taking the same risk inside the corporation.

It’s all your capital. It’s all your income. The only difference is is now you’re going to get to keep more of it. You get to keep more of this passive income here at a personal level. Excuse me. And over here, the one difference I might have him change is that any of the conservative plays he was going to make that create passive income that he looked for equivalent ETFs that actually reinvest dividends and interest and such inside of the trust.

so that it’s actually not going to be deemed as passive income and it will instead be deemed as a capital gain. Now, capital gains taxes are still not fun whether you earn them here or you earn them there, but as of today, we no longer have this two thirds inclusion on the table right now for incorporated business owners. So we don’t have to actually worry about paying more on the capital gain or less. You actually are gonna be paying the same amount.

as of today, as of recording this here in 2025, which means you are in a net better situation because you’re keeping more of this private lending income. You’re going to keep this. I’m going to say you’re actually improving in this part as well, because he was going to take dividends at a personal level over here with the stock portfolio. I’m encouraging inside the corporation. try to pick ETFs that are going to create capital gains instead of dividends so that you can can kick.

and you’ll get taxed at about, we’ll call it around 25 % of the total capital gain is what that’s going to work out to plus any of the tax free portion of the capital gain right now, 50 % can come out tax free through the capital dividend account upon any sale, any realized capital gains. So just by doing this one flip flop, we now have a massive, massive improvement to the overall

long-term trajectory. We don’t even have to run the numbers on it because again we’re not comparing different investments we’re just comparing what we get to keep in our pocket versus what we were going to send off to the CRA.

Jon Orr: And when you strategize this with him on the call, what was his next step?

Kyle Pearce: So his next step right now, first of all, at the end of the call, he went, that is more than he was looking for, right? Because now he’s like rethinking some of the ideas that he was going to put in motion. Initially, he was talking about just getting an IFA going. So he’s still consistent on the idea of an immediate financing arrangement inside the corporation. We did discuss personal leverage against corporate assets.

We talked about how that’s possible in the future as a policy grows. However, we also discussed how at that point in the journey, there’s probably gonna be more convenient assets in his world, i.e. his primary residence, that he might choose to use that leverage against with the same logic in mind here, right? Right now we’re saying, listen, you’re leveraging against two different assets to make two different investments. We flip-flopped them.

The same will be true as he does this work and he continues to grow his net worth and grow his assets in his life. He will have an option down the road to leverage against different assets in order to create more cash flow in his life without triggering additional taxes that could be against a corporate asset. But with doing that comes other things we have to do like paying our corporation for the right to do so.

like making sure we get independent legal tax advice, like doing all of these different things that may be more work than they’re worth when we know that we have other assets on the personal side that we can use the same leverage against without as much hassle, without as much cost. But you have the asset, we call it the foundational asset sitting inside the corporation, which is giving you the optionality to feel confident.

to use that type of conservative leverage. Whereas if you didn’t have it, you probably wouldn’t use leverage against say your personal or primary residence at some point down the road. So here it’s all about optionality and creating yourself the right plan so that you are in a position to do the best move for you now, medium term and long term so that you can maximize cashflow and maximize your net worth while keeping your legacy in your estate intact.

Jon Orr: Yeah, and these are the types of conversations we often have with folks who reach out to us who are in, phase three of their wealth building journey, which is about protecting your hard earned, your money, you’re protecting your capital, protecting the amount of, you know, in your nest egg, the growth that you’ve been working towards, you know, your independent financial number. That’s the focus of phase three is how to

how to grow that, but also protect it and structures that protect it. Those are the types of conversations we have with our clients in that phase. Phase two is about kind of just awakening and accumulating assets that are, say, income producing assets and how do we structure that. Phase one is like the awakening to focus on assets versus, say, making sure that you’re covering all debts. Phase four, you know, I’m jumping around here in the phases, but phase four,

specifically is some higher advanced strategies that some of our high net worth clients, some of our business owners can take advantage of around fully optimizing the tax structures at a say a complex level. if you’re unsure of the phase you’re currently in, you can head on over to CanadianWellSecrets.com forward slash discovery. We have a short survey there for you to fill out to help you discover which phase you are in. That link will also get you an access to say have that conversation with us so that we can kind of navigate your unique situation and develop a strategy that best meets your financial journey.

Canadian Wealth Secrets is an informative podcast that digs into the intricacies of building a robust portfolio, maximizing dividend returns, the nuances of real estate investment, and the complexities of business finance, while offering expert advice on wealth management, navigating capital gains tax, and understanding the role of financial institutions in personal finance.

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