My name is Mark Goodfield. Welcome to The Blunt Bean Counter ™, a blog that shares my thoughts on income taxes, finance and the psychology of money. I am a Chartered Professional Accountant and a partner with a National Accounting Firm in Toronto. This blog is meant for everyone, but in particular for high net worth individuals and owners of private corporations. The views and opinions expressed in this blog are written solely in my personal capacity and cannot be attributed to the accounting firm with which I am affiliated. My posts are blunt, opinionated and even have a twist of humor/sarcasm. You've been warned.

Monday, February 20, 2017

The Salary vs Dividend Dilemma 2017 Version - RRSP or Not? - What Small Business Owners Need to Know


In part one of my salary vs dividend dilemma update, I provided you with a summary of the absolute and deferred income tax savings available in respect of paying a dividend versus a salary. I concluded that in Ontario, from an absolute income tax basis, you are somewhat indifferent as to whether you receive a salary or dividend, from your
corporation, if you are a high-rate taxpayer. For the other provinces, this nominal tax (dis)advantage also holds true (except for some provinces where your active business income is not eligible for the small business deduction). However, speak to your accountant, to review your specific situation.

I also reflected that there is a significant tax deferral advantage for active income, whether eligible for the small business deduction or not.

An issue that naturally falls out of the above tax rate discussion is whether you as a small business owner/professional are better off financially paying a salary and contributing to your RRSP or leaving the money in your corporation, creating your own "corporate RRSP", so to speak?

Funding Your RRSP vs Leaving the Money in Your Corporation?


Jamie Golombek, the Managing Director, Tax & Estate Planning of CIBC has written several outstanding papers on whether small business owners should take a salary or dividend and whether they should contribute to their RRSP or leave the money in their corporation.

When I initially wrote the draft for this blog post a couple months ago, I had a summary of Jamie's papers by year and their conclusions. But as fate would have it, Jamie and CIBC just issued a new report earlier this month, titled "RRSPs: A Smart Choice for Business Owners". Thus, I just deleted all my prior work to avoid any confusion.

In his latest paper, Jamie now concludes, that for a 30 year time horizon, with a 5% rate of return, where tax rates remain constant, small business owners are better off to take a salary and make a RRSP contribution where their RRSPs earn interest, eligible dividends or they realize capital gains annually. This is also true where you hold a balanced portfolio in your RRSP.

The exception is where you have deferred capital gains (not typically likely). This conclusion may come as a bit of a shock to many small business owners who have been leaving their excess cash in their corporation and creating their own "Corporate RRSP".

As you would expect, the paper notes that where your personal tax rate is lower at RRSP/RRIF withdrawal, this strategy is more beneficial and where your tax rate is higher, the strategy is less beneficial or possibly detrimental.

The conclusions in this paper reflect that income tax strategies must be fluid and answers are not static. Jamie's strategy/conclusions in respect of funding a RRSP have changed significantly since the issuance of his first paper back in 2010, due to changes in personal and corporate tax rates and there effect upon the integration of the income tax system.

Here is a link to a recent interview Jamie did on BNN where he discusses his new paper.

Jim Yih, a well-known financial commentator and author of the popular blog Retire Happy had this to say on my LinkedIn page after I posted Jamie's article: "Hey Mark, my accountant did the same calculation for me based on being in Alberta, the math in this article and results marginally favoured investing in the company over RRSPs. People need to do the math because the assumptions might change the results. Still a thought provoking article!"

Thus, as Jim notes and Jamie discusses in his BNN interview, it is very important you review the CIBC paper in context of your individual circumstances. Various factors such as age, time to retirement (CIBC uses a 30 year time horizon), other income sources, family income, rates or return and provincial tax rates all need to be considered. For example: if both spouses are shareholders of the corporation, have limited or no other income and do not have significant lifestyle needs, then paying dividends would likely be the way to go.

Other Considerations for Paying a Salary in Lieu of a Dividend


Based on Jamie's data, you would likely lean to paying a salary and contributing to your RRSP. However, there are other factors you may wish consider. I briefly discuss some of these factors below.

Self-Discipline - I have noted in the past, that as a consequence of utilizing a dividend only strategy, you “park” your retirement savings in an easily accessible and tempting location (an operating company or a holding company) and human nature being what it is (I have observed this on many an occasion), one may tend to dip into this cash for personal use purposes ranging from home renovations to vacations to buying an expensive sports car. Thus, financial discipline and restraint is very important if you leave your money in your corporation and don't make a RRSP contribution.

CPP - If a salary is not paid, your CPP entitlement at retirement will be significantly reduced or eliminated. However, as Jamie notes in his paper, "it is conceivable that, over the course of a 40 years career, the premium savings might be independently invested in a diversified portfolio to ultimately produce a larger pension income". I would suggest most people do not have the financial control to invest non-contributed CPP funds each month and thus, I personally still favour contributing unless you are extremely disciplined.

OAS Clawback - For income tax purposes, the actual dividend you receive from a private corporation will be grossed-up for tax purposes. This "artificial increase" in income can result in a partial clawback of your old age security, subject to your actual net income.

Child Care - For those of you with young families, if you are the lower income spouse and paid solely by dividend, you will not have any earned income and will not be entitled to claim your child care costs. If you and your spouse are both shareholders and take only dividends, you may need to take some salary to maximize your child care claim.

Capital Gains Exemption - To be eligible to access the $835,716 capital gains exemption (this amount is indexed each year) upon the sale of your corporation’s shares, certain criteria must be met (see this post I wrote on this complex topic). If you utilize the dividend strategy, your corporation may accumulate too much cash and put the corporation offside the rules.

Asset Protection – If you accumulate substantial funds in your corporation, they could be at risk should the company be sued. You may be able to alleviate this concern by utilizing a holding company or a family trust with a holding company beneficiary.

Research and Development – If your corporation is engaged in R&D, a dividend only strategy will likely result in a reduced Investment Tax Credits claim as the company’s taxable income will be higher.

Remuneration planning is very fact specific. You should always consult your professional advisor before making a decision in regard to paying a salary and/or dividend.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.

Monday, February 13, 2017

The Salary vs Dividend Dilemma 2017 Version - What Small Business Owners Need to Know

In January 2013 (my, how time flies), I wrote a three-part series on the question of whether small business owners were better off taking a salary or dividend. I have been asked numerous times by readers, to update the series, but since it took 15 hours or so to write, I resisted.

However, I have cried uncle and decided to provide a short update on the absolute and deferred tax savings rates and re-iterate some of the issues you need to consider in making this decision.

Bloggers Note: I live and work in Ontario, so I have used Ontario tax rates in my analysis. The discussion should be relevant for most provinces, although there are a couple outlier provinces, so please discuss any tax planning with your accountant.


Absolute vs Deferred Tax Savings


There are two concepts that need to be understood in relation to this discussion:

1. Absolute income tax savings
2. The power of the deferral of income tax and the time value of money  

I illustrate these two concepts below.

I had some issues with the formatting of the charts that I could not fix, so I apologize in advance that they are not aligned perfectly. 

Absolute Income Tax Savings


Absolute income tax savings are the actual tax savings a business owner would have by utilizing a dividend only strategy over a salary strategy or vice versa. In 2013, using a dividend only strategy resulted in a significant absolute tax savings benefit (3.38%). i.e. you would have $338 more dollars in your pocket if you paid yourself a $10,000 dividend in 2013 than if you paid yourself a salary. However, due to the various increases in income taxes implemented by the Liberals, there is essentially no difference in 2017 on income eligible for the small business tax rate for a high rate taxpayer.

This is demonstrated below. Please note I have excluded employer health tax.

Income Eligible for the Small Business Deduction ("SBD")


Income earned by the business                                         100.00
Corporate taxes payable                                                   (15.00)
Income available as an ineligible dividend                              85.00
Personal tax payable on ineligible dividend                          (38.51)
Net cash to shareholder                                                       46.49

Total corporate and personal tax                                      53.51

Personal tax at top rate                                                        53.53

Savings/(cost) of earning income in a corporation
and paying it as an ineligible dividend                               0.02

If you account for employer taxes, there is approximately a .009% tax savings in paying an ineligible dividend vs taking a salary.

Income not Eligible for the SBD


Income earned by the business                                            100.00
Corporate taxes payable                                                      (26.50)
Income available as an eligible dividend                                   73.50
Personal tax payable on eligible dividend                               (28.91)
Net cash to shareholder                                                         44.59

Total corporate and personal tax                                        55.41

Personal tax at top rate                                                         53.53

Savings/(cost) of earning income in a corporation
and paying it as an eligible dividend                                  (1.88)

If you account for employer taxes, the tax cost of earning income not eligible for the small business rate comes down to about 1%.

The long and short of all this is; from an absolute income tax perspective, you are pretty much indifferent on taking salary or dividends unless tax rates are changed in future budgets.

The Deferral on Corporate Income


The chart below reflects the amount of income that is deferred when a business owner leaves excess funds in their corporation.

Active Income Eligible for SBD

Tax at top personal rates                                                     53.53
Tax at small business corporate tax rates                             15.00
Tax deferral from retaining income                                 38.53


Active Income not Eligible for SBD

Tax at top personal rates                                                     53.53
Tax at general corporate tax rates                                        26.50
Tax deferral from retaining income                                 27.03


The above reflects there is a substantial tax deferral when you leave income in your corporation. This deferral allows you to invest that money in your corporation to grow your company, or just invest it passively in stocks, real estate or other investments. However, it is important to understand, this is just a tax deferral, not an absolute tax saving.

The "Bonusing Down" Decision


In the old days (5 years ago) the “conventional wisdom” was to pay a bonus when your corporate taxable income exceeded the small business limit. However, these days, most accountants suggest their clients pay the higher general rate of corporate income tax, if the money is not needed in the short-term (3-5 years depending upon various investment return assumptions) or better yet, the long term (10-25 years). The reason for this is there is a tax deferral of 27.03% as noted above, while the absolute tax cost is 1.88% or less. In most cases where money is not required, the investment returns on the 27% deferral should significantly exceed the small absolute tax cost.

What Jamie Says


Jamie Golombek, the Managing Director, Tax & Estate Planning of CIBC has written several outstanding papers on whether small business owners should take a salary or dividend.

In 2011, he wrote a paper titled “Bye-bye Bonus! Why small business owners may prefer dividends over a bonus”. This report was updated in 2015 and can be found here. In that report Jamie stated that “Although dependent on the long term assumed rate of return and time horizon, if funds are not needed to fund current lifestyle, it may be advisable to have SBD Income initially taxed inside the corporation at relatively low corporate tax rates. The after-tax SBD Income can then be retained and invested in the corporation with the after-tax amount later paid out as a dividend to the shareholder, so as to enjoy a significant tax deferral of SBD Income within the corporation.” This was essentially the same conclusion Jamie came to for active business income not subject to the small business rate.

With the 4% increase in personal tax rates since the publication of Jamie’s 2015 paper, one would assume his conclusions would still hold true. To be sure, I asked him recently to confirm my assumption.

One of the members of his CIBC tax estate planning team confirmed that because of the significant tax deferral advantage for active business income, they would still support payment of dividends over salary in many cases. However, there are two exceptions to this rule.

1. TFSAs - In Jamie’s 2015 report, TFSAs for Business Owners, he commented that it may be better to invest in a TFSA than in a corporation for most types of income (the main exception being deferred capital gains). That is the same conclusion I came to in this blog post.

2. RRSPs - I will discuss this exception next week (in context of a new paper Jamie released just last week) when I review whether you should pay a salary and contribute to a RRSP, or just leave the money in your company and pay dividends, as required, over time.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.