My name is Mark Goodfield and I am a tax partner and the managing partner of Cunningham LLP in Toronto. This blog is about income tax, business, the psychology of money and investing topics and is meant for taxpayers no matter their income bracket, but in particular for high net worth individuals and entrepreneurs who own private corporations. I also blog about whatever else crosses my mind; I have to entertain myself. This is my personal blog and the views and opinions expressed in this blog do not reflect the position of Cunningham LLP. I am blunt and opinionated (at least for a Chartered Professional Accountant). You've been warned.

The blogs posted on The Blunt Bean Counter provide information of a general nature and should not be considered specific advice, as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

Monday, January 6, 2014

Salary or Dividend? A Taxing Dilemma for Small Business Owners -2014 Update

Effective January 1, 2014 the personal income tax rate on non-eligible dividends paid by private corporations will increase. As result of this uptick in rates, the absolute income savings that were available in most provinces in 2013, when small business owners paid themselves by dividends (as opposed to salary) have been virtually eliminated.  

With these changes, the government has achieved almost perfect integration, at least in my home province of Ontario. By integration, I mean a person will be indifferent as to whether they receive a dividend or salary from a private corporation, since the ultimate income tax cost (total of both corporate and personal taxes) is exactly the same.  

Although the government has effectively removed any absolute income tax savings, a significant income tax deferral is still available where corporations earn active business income. For example, if a corporation earns active income in Ontario, the corporate tax rate is only 15.5% as opposed to a personal tax rate of 46.41% (on taxable income over $136,270). This means to the extent that a small business owner does not need all their corporate earnings to live on and can leave funds in their corporation, they are deferring 30.91% in taxes (34.03% if they are a super-tax rate taxpayer paying 49.53%).  

Jamie Golombek, the Managing Director, Tax & Estate Planning of CIBC, recently released a report titled “The Compensation Conundrum: Will it be salary or dividends?”  This is Jamie’s third report in an excellent series on owner-manager remuneration, the first two being “Rethinking RRSPs for Business Owners: Why Taking a Salary May Not Make Sense” and “Bye-bye Bonus! Why small business owners may prefer dividends over a bonus”.

The chart below, taken from Jamie’s most recent report, reflects the impact of the dividend tax changes on small business owners, who distribute their income as non-eligible dividends instead of salary; where their corporations are eligible for the $500,000 small business deduction limit (“SBD”). The absolute tax rates which Jamie denotes as tax rate (dis)-advantage reflect significant decreases from 2013 to 2014, while the tax deferral advantage is either unaffected or has grown larger in almost all provinces. For example: In Ontario, in 2013, there was an absolute tax savings of 3.21% if a small business owner received non-eligible dividends instead of salary. However, in 2014, that benefit is now only .12%. The tax deferral remains the same at 34.03%.

Tax rate (dis)advantage and tax deferral advantage
on SBD Income in 2013 and 2014
                                             2013                                                     2014
                       Tax Rate                    Tax                    Tax Rate                    Tax
                          (Dis)-                  Deferral                  (Dis)-                  Deferral
Province   advantage          Advantage          advantage          Advantage
AB                    1.17%                   25.00%                 (0.69%)                 25.00%
BC                     1.04%                   30.20%                 (0.56%)                 32.30%
MB                   0.56%                   35.40%                 (0.89%)                 35.40%
NB                    1.65%                   29.57%                   0.91%                   31.34%
NL                     1.84%                   27.30%                   0.94%                   27.30%
NS                    4.54%                   35.50%                   2.40%                   36.00%
ON                   3.21%                   34.03%                   0.12%                   34.03%
PE                   (0.18%)                 32.73%                 (1.95%)                 31.87%
QU                  (0.25%)                 30.97%                 (1.26%)                 30.97%
SK                     2.00%                   31.00%                   0.27%                   31.00%
Chart reproduced with permission from Jamie Golombek, the Managing Director, Tax & Estate Planning of CIBC from his recently released report “The Compensation Conundrum: Will it be salary or dividends?” December 2013.

For active business income (“ABI”) in excess of the $500,000 small business deduction limit (i.e.: taxable income from $500,001 upwards) the dividends distributed are considered eligible dividends and thus the absolute tax savings and tax deferral advantage are largely unaffected as noted below.

Tax rate (dis)advantage and tax deferral advantage
on ABI Income in 2013 and 2014
                                             2013                                                     2014
                       Tax Rate                    Tax                    Tax Rate                    Tax
                          (Dis)-                  Deferral                  (Dis)-                  Deferral
Province   advantage          Advantage          advantage          Advantage
AB                   (0.47%)                 14.00%                 (0.47%)                 14.00%
BC                   (1.19%)                 17.95%                 (1.42%)                 19.80%
MB                 (4.15%)                 19.40%                 (4.15%)                 19.40%
NB                    0.63%                   19.06%                 (0.13%)                 19.84%
NL                   (2.65%)                 13.30%                 (2.65%)                 13.30%
NS                   (5.88%)                 19.00%                 (5.88%)                 19.00%
ON                  (1.85%)                 23.03%                 (1.83%)                 23.03%
PE                   (3.44%)                 16.37%                 (3.44%)                 16.37%
QU                  (2.68%)                 23.07%                 (2.68%)                 23.07%
SK                   (1.11%)                 17.00%                 (1.11%)                 17.00%
Chart reproduced with permission from Jamie Golombek, the Managing Director, Tax & Estate Planning of CIBC from his recently released report “The Compensation Conundrum: Will it be salary or dividends?” December 2013.

Last January I wrote extensively about the decision of whether to pay a salary or a dividend and the benefit of accumulating a “retirement fund” inside your corporation by taking advantage of the income tax deferral. Part 1 discussed conventional wisdom in respect of the salary versus dividend issues, Part 2 demonstrated the numerical benefits of deferring income and Part 3 discussed the various issues that can impact that decision. I do not have the time or the energy to redo these posts and much of what I said is still relevant or covered by Jamie's new report. However, I would suggest there are two key changes.

If your remuneration strategy was to pay yourself a salary to the RRSP limit and then pay yourself a dividend on any amounts over the RRSP limit, the increased tax rate on non-eligible dividends means that in many provinces, there will be little to no benefit to remunerate yourself in this manner in 2014 (EHT should be considered in this analysis).

If you leave after-tax corporate funds to grow in your company, you will now pay more income tax on the eventual withdrawal of those funds, to the extent the funds are withdrawn as non-eligible dividends.

With the change to the taxation of non-eligible dividends, small business owners need to consult their accountants early in 2014 to determine if they need to consider changing the manner in which they are remunerated.