In Ontario, You Are Rich If You Make $220,000!

I think most people would agree, that those of us who make the most money ("the rich") should be taxed at higher marginal tax rates. However, what we may not all agree upon is what level of salary/income makes you “rich” and what the highest marginal tax rates should be. In Ontario, where supposedly only 2% of income earners make more than $150,000, “sort of rich” now starts at $150,000 and you are considered rich at $220,000.

I guess it is all a matter of perspective (my accounting/tax practice and blog is/are directed at high net worth people and small business owners so my living depends on the “rich”) but to me, if you make $200,000 or even $300,000, you are doing extremely well, but are far from being wealthy or rich, especially if you live in Toronto.

A few weeks ago I was undertaking some dividend tax planning for a family that has various family members scattered across Canada. When I compared the taxes that were payable by the child in Alberta and the child in Ontario, I thought I had made an error in calculation. There was a massive tax payable variance on this dividend.

That Alberta and Ontario have a significant taxation gap is not new news. What caught me off guard, and I think will catch several Ontarians off guard at tax time this year, is the impact of the new marginal tax rate threshold in Ontario. In 2013, Ontario taxed incomes over $509,001 at the highest marginal rate. For 2014, the $514,090 threshold in Ontario was dropped to $220,000, and a second level of higher tax rates was introduced for those with income between $150,000 and $220,000.

The excellent website Taxtips.ca, reflects that the highest combined marginal rate for an Alberta taxpayer on a non-eligible dividend paid by the typical small business is 29.36%. In Ontario, that rate for someone who makes over $220,000 is 40.13%. If a small business pays a $200,000 dividend to a high marginal rate child living in Alberta, he/she will owe approximately $59,000 in tax on that dividend; while that same dividend will be taxed to the other child in Ontario at approximately $80,000.

For your information, the highest marginal rate on employment and interest income in Alberta is 39% versus 49.53% in Ontario. Although it should be noted that Alberta considers you rich at $136,270.

The point of this post was twofold. Firstly, to warn those of you who earn more than $150,000 in Ontario, that you may owe substantially more income tax next April; especially if you have self-employment, rental income, or other investments (not subject to tax withholding) and secondly, to note the huge taxation discrepancy between Alberta and Ontario. I expect there are going to be many Ontario accountants dealing with angry nouveau riche clients next April.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts 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.

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.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts 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. Please note the blog post is time sensitive and subject to changes in legislation or law.

Should You Discuss Your Salary with Friends, Co-Workers or Family?

I have written several blogs on various money taboos; from discussing your will with your family to planning for inheritances. I enjoy writing or discussing these sacred topics because I like to challenge some of our financial conventional wisdom's. Frankly, I find some people just so uptight on these topics that I enjoy watching their reactions and/or reading their comments on my blog.

A major taboo is discussing your salary with friends, co-workers and family. Although I am personally fairly open to discussing many sacred money topics, I think discussing your salary is generally not a prudent action. However, are there any situations in which a discreet discussion of salary may be advantageous to one or both parties?
  

Friends

Personally, I see few if any circumstances that would ever merit discussing your salary with your friends. The one possible exception may be where your friend is in the same or similar profession. I will discuss that exception in detail below. Otherwise, I see only risk in discussing this topic with friends. Some may lack discretion and inform others of your salary, while others may be jealous or harbor resentment. 

Co-Workers

In the case of co-workers and friends in similar professions, I can see at least 2 reasons why someone would divulge their salary. The first reason being to ensure equality of salary. Many people want to know they are being paid equally, especially in industries where there may not be gender equality. The issue becomes what you do with that information? Do you run to your employer and tell them Don down the hall told you he is making $2,000 more? You put Don at risk with your employer (which is why Don may be hesitant to discuss the issue in the first place), and if you confront your employer you risk your own job, whether your employer is legally entitled to dismiss you or not.

On the other hand, if an employee is discreet, they can use their knowledge of wage inequality in salary discussions to know how far they could try and push for a salary increase, assuming they feel

confident they are a valued employee. Both the above situations involve risk to the employee and their co-worker which is why I would suggest many co-workers do not discuss their salaries (Although, I may have employer bias; as I would not be pleased if someone told me during a salary review that they deserve to be paid as much as Mary or Sam).

Another reason for discussing your salary amongst friends and co-workers in the same profession would be if you or they are job shopping. If you know Jane makes $70,000 working for an engineering firm and your engineering firm only pays you $60,000, you may wish to consider applying for a job at Jane’s firm if all other employment variables are equal. Alternatively, this information may be helpful in pushing for a raise at your current firm, as knowing what other firms are paying and what your firm really needs to pay to compete would be valuable knowledge.

Family

I would think that most people share their salary with their spouse. However, I know there are spouses who try and keep that information private or provide partial disclosure. In some cases they think the information is private, in others they feel their spouse will spend more money if they know what they earn, and finally, many spouses are not forthright so their spouse will be in the dark should there ever be a marital breakdown.

I see no reason to provide such information to siblings, unless it would be useful information for their own careers. Even the most well intentioned sibling could say something by accident and we all know about sibling rivalry and jealousy.

How about younger children? I found a couple of articles on this topic, specifically this New York Times Article titled “Daddy Are We Rich? and Other Tough Questions”. The author, Ron Lieber, discusses ways to handle the question without providing specific income in various situations. The article puts forth an elegant solution by Gary Shor, a financial planner, where he suggests parents turn the question upside down by detailing the expenses they incur to live their current lifestyle. This provides their children with a sense of how much salary would be needed to afford those expenses and what kind of professions could provide such income for their children in the future.

For full disclosure, the reason I wrote this blog is that I recall as a university student considering following in my father’s footsteps. He was a baseball player (a left handed pitcher who was asked to try out for a Cleveland Indian farm team when younger) and I asked him how much do major league pitchers make? 

Just joking about asking him how much pitchers make, but he was asked to try out for a minor league team and believe it or not, in the late 50’s accountants made more than baseball players. Then there was my grandmother who forbade him from trying out for the Indians, so in the end my father decided against baseball and he became an accountant. I have digressed as I often do, however, I do remember having a frank discussion with him about what he made as an accountant that I found very enlightening in making my career choice. In retrospect, I would have preferred it if he had framed our discussion based on what accountants make per hour they work (given the hours I have worked over my career), instead of on a gross annual basis.

Anyways, as I stated at the outset, I would generally dissuade anyone from disclosing their salary, other than where that information provides them or someone they trust, with knowledge to leverage a greater future salary. And in those rare cases when you do disclose your salary, always understand you are taking a huge risk with that information being leaked – intentionally or unintentionally.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts 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.

Tax Tweets of the Day for the Week Ending February 22, 2013

My Twitter tax tips for this week are listed below. My twitter handle is @bluntbeancountr. If you will be receiving a severance payment/retiring allowance in 2013, or are planning to withdraw funds from your RRSP in 2013, ensure you pay attention to the first tip.

Tips for Week of February 18 - February 22, 2013

Receiving a retiring allowance? Cashing an RRSP this year? Beware, taxes withheld are often less than the tax you will owe. #blunttaxtip.

Note: For a discussion of this issue, see this blog post.

US citizens must file a 1040 US return. If you are a Cdn resident earning #Rental Income in the US, you must file a 1040NR. #blunttaxtip

Do you own shares in any bankrupt #stocks? You can file an election to claim the capital loss this year. #blunttaxtip

When filing a deceased parent/grandparent’s return, ensure you report any deemed dispositions of stocks or real estate. #blunttaxtip

Note: Upon passing, if property is not transferred to a spouse, you are deemed to dispose of your capital property at death as if you actually sold the shares or real estate. The determination of the cost base of that property can often be problematic to say the least.

Interest rates are very low; consider a 1% prescribed #loan to your spouse. The 1% interest rate is locked in forever. #blunttaxtip

Note: For a discussion of this issue, see this blog post.

    

White Paper on Salary or Dividend for Small Corporate Business Owners

My recent three part series on whether small corporate business owners should take Salary or Dividends , The Numbers and The Issues to Consider has been made into a more readable white paper on my firms Cunningham LLP's website. You can download the paper by following this link. Note: Full disclosure; you will have to submit your personal information.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts 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.

Part 3 - Salary or Dividend? Issues to Consider

In my blog post yesterday, the numbers reflected that corporate small business owners, who employ a dividend only strategy and retain the deferred income tax savings in their corporations, will end up with more after-tax funds than if they were remunerated by salary.

The above statement begs the question: why would any small business owner pay themselves by salary, in any case other than where they need to show T4 income on their personal income tax return for a specific purpose?  I examine some of the possible reasons below.

Loss of RRSP

 

One of the most significant issues that arise when a corporate small business owner remunerates themselves solely by dividends is that they can no longer contribute to an RRSP. The reason for this is that your RRSP deduction limit is dependent upon having “earned income”, which includes employment income, but does not include dividends.

Jamie Golombek suggests in his 2011 paper "Bye-bye Bonus! Why small business owners may prefer dividends over a bonus" that “a business owner with no other source of earned income needs to consider whether he or she would be better off with a dividends-only strategy, rather than paying out enough salary/bonus to maximize his or her RRSP contributions”. He goes on to reference his 2010 paper “Rethinking RRSPs for Business Owners: Why Taking a Salary May Not Make Sense ” which concludes that small business owners whose corporations do not make more than $500,000 of taxable income are typically better off not contributing to an RRSP, but in essence using their corporations to create their own “corporate RRSP” (my term, not Jamie's).

Jamie supported his assertion by comparing two scenarios’: the first where a salary is paid and the maximum RRSP contribution is made and the second where dividends are paid and surplus funds are invested in the corporation. He then utilized 3 different portfolios to test his hypothesis. His model showed that the dividend only remuneration strategy outperformed the salary strategy over all three portfolios.

Jamie noted three reasons for this result (the first two were discussed in yesterday's blog post): (1) There is an absolute tax saving advantage by paying dividends over salary (2) The income tax deferral advantage provides more investable funds and (3) Within a RRSP, capital gains lose their tax preferred status of only being 50% taxable, since they are 100% taxable as income when withdrawn from a RRSP.

It is slightly ironic that Jamie’s numbers support building your own “corporate RRSP", since he has noted in the past that the rate of RRSP withdrawals suggest that Canadians do not consider their RRSPs as the Holy Grail of retirement savings. Thus, by  extension, if Canadians are not repelled by the "invisible fence" surrounding their RRSPs, I wonder if Jamie is concerned small business owners will not be disciplined enough to keep their hand out of their new "corporate RRSP", held by an unfenced holding company?

In the David Milstead article I discussed yesterday, Clay Gillespie of Rogers Group Financial in Vancouver says that although he likes the dividend strategy, he notes it could be derailed by human nature. “People tend to spend money they can get their hands on, he said, as opposed to dollars socked away in tax-advantaged retirement plans. It's whether people will be disciplined enough to take the money and invest in a way to take advantage of the strategy. It's important to make sure retirement savings are sacrosanct, given that future CPP benefits (but not benefits accrued previously) will be lost under this strategy.”

Before I leave this topic, I want to clarify one thing about the deferred corporate funds that accumulate if you utilize a dividend only strategy. There are two components to these deferred funds: 1. Funds that would have been contributed to your RRSP if you had used a salary strategy and 2. Excess funds that were not required for your day to day living expenses and were left in the corporation to take advantage of the corporate income tax deferral. If you were to only remove the “excess funds” component from your corporation, you at worst would still have achieved an absolute income tax savings. The insidious aspect of these deferred funds is where a small business owner withdraws money that would have been “protected” RRSP money under a salary strategy.

Despite my reservations about human nature, I must concede, if you are financially disciplined, a dividend only strategy “sans RRSP” may make sense subject to the comments below.

No CPP

If a salary is not paid, your CPP entitlement at retirement will be significantly reduced, as you cannot contribute to CPP unless you are paid a salary or earn self-employment income. For 2013, the maximum CPP entitlement is approximately $12,200 (not to mention the disability and death benefit CPP provides). It must be noted that the combined cost of the employee and employer CPP premiums’ for 2013 is almost $4,800.

OAS Clawback

For income tax purposes, the actual dividend you receive from a private corporation will typically be grossed-up by 25%. For example, if you were paid a dividend of $50,000, you would report $62,500 on your income tax return. 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 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.

$750,000 Capital Gains Exemption

To be eligible to access the $750,000 capital gains exemption upon the sale of your corporation’s shares, certain criteria must be met. If you utilize the dividend strategy, your corporation or your holding company will accumulate a substantial cash position that may put the corporation offside in terms of the rules. If an offer to purchase your company comes out of left field, your shares may not qualify for the $750,000 capital gains exemption.

In order to alleviate the above concerns, you may be able to “purify” your corporation of excess cash. If you intend to use a dividend only remuneration strategy, you may want to consider implementing a family trust which would potentially have your spouse, children and a holding company as beneficiaries. The holding company would provide an outlet to remove excess cash so that you could still claim the capital gains exemption, while providing creditor protection (see below). If a family trust is not practical, there are alternative ways to purify your corporation, but some of these can be problematic or expensive to undertake.

Creditor Protection

If you utilize a dividend only strategy, the cash you are accumulating becomes exposed to creditors, should your business fail or you are sued by a customer, employee etc. Thus, at a minimum, you would want a holding company as the owner of the corporation (excess cash is paid as a tax-free dividend to the holding company) or have a holding company as a beneficiary of the family trust as noted above.

Although a holding company may provide creditor protection if you are sued by the creditors of your operating company, these assets would be at risk if you had to declare personal bankruptcy for any reason. RRSPs on the other hand are protected from creditors upon bankruptcy, except for any contributions made within the last 12 months.

Research and Development (“R&D”) Companies

For corporate small businesses engaged in R&D, a dividend only strategy may not be the correct strategy. This is because the expenditure limit for purposes of claiming Investment Tax Credits (“ITC”) is reduced where taxable income exceeds certain thresholds. Consequently, the payment of a salary will reduce taxable income and potentially allow for a larger ITC claim. In addition, the owner’s salary (specified employees) may be an eligible R&D expense, whereas dividends provide no R&D tax benefit.

Summary

My practical experience is mixed. Some people are not willing to give up taking a salary and they definitely do not want to stop contributing to their RRSP. Some also do not like the idea of not contributing to CPP and others have concerns regarding their capital gains exemption eligibility. However, the numbers, which need to be run individually for each person’s specific circumstances, do reflect that a dividend only strategy is advantageous in many circumstances and some clients have taken this route. First and foremost, you must be honest with yourself and determine whether you will be disciplined enough to not dip into your easily accessible corporate retirement fund and whether you can mitigate some of the negative consequences associated with a dividend only remuneration strategy.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts 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. Please note the blog post is time sensitive and subject to changes in legislation or law.

Part 2 - Salary or Dividend? Numbers, Numbers and More Numbers

In yesterday’s blog post, I discussed the so called “conventional wisdom” in regard to corporate small business owner remuneration. Today, I play accountant and overwhelm you with numbers. Sarcasm aside, this conversation cannot happen without numbers. If this topic is of interest to you, you will probably want to print this blog post and the related links and review this discussion when you have some spare time. You may also want a bottle of scotch and glass beside you.

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. Please note that for the purpose of the illustrations, I have used Ontario income tax rates, however, these two concepts hold true for every province.

Absolute Income Tax Savings

The following reflects the absolute income tax savings a business owner would have by utilizing a dividend only strategy over a salary strategy. This example assumes the individual’s income is less than $500,000 (below the Ontario super tax rate) and all personal income is taxed at the marginal income tax rate of 46.41% (the highest non-super tax rate).

Corporate taxable income	$100,000
Corporate income tax	($15,500)	[A]
Corporate funds available for dividends	$ 84,500
Dividend	$ 84,500
Personal income tax on dividend	$ 27,522	[B]
Total corporate and personal taxes	$ 43,022	[A+B]
Tax on salary of $100,000 (no EHT)	$ 46,410
Absolute income tax savings of paying
dividend instead of a salary	$   3,388	($46,410-$43,022)

Below, I again reflect the absolute income tax savings a business owner would have by utilizing a dividend only strategy over a salary strategy. However, this time I assume the $100,000 salary or $84,500 dividend is the business owner's only source of income and they benefit from the lower marginal income tax rates. The numbers below are for 2013, calculated without the use of computer software, so they may be slightly off.

Corporate taxable income	$100,000
Corporate income tax	($15,500)	[A]
Corporate funds available for dividends	$ 84,500
Dividend	$ 84,500
Personal income tax on dividend	$  9,265	[B]
Total corporate and personal taxes	$ 24,765	[A+B]
Tax on salary of $100,000 (no EHT)	$ 26,697
Absolute income tax savings of paying
dividend instead of a salary	$   1,932	($26,697-$24,765)

As reflected in both examples above, there is an absolute income tax saving of approximately 1.9% to 3.4% by utilizing a dividend only strategy and this does not even account for the additional provincial payroll levies that may be applicable.

The Deferral on Corporate Income Eligible for the SBD Limit

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

 

Salary at highest marginal rate (non super tax rate)	46.41%
Corporate income tax rate on income under $500,000	15.50%
Income tax deferred by retaining surplus cash in your corporation	30.91%

Note: this is not an absolute income tax saving, just a deferral of income tax until you require the money.

The value of the deferral is directly correlated to the number of years you leave the funds in the corporation and the return earned on those funds. An additional benefit will be the possibility to “income smooth” those funds when distributed from your corporation as dividends. It may be possible to pay dividends out over time such that you end up paying substantially less than 46.41% in total tax (or 43.02% in total using the dividend strategy example).

Jamie Golombek quantifies the deferral benefit in his 2011 report I mentioned yesterday. Using $100,000 of after-tax small business income, over a 40 year period, with a 5% return, he says that one would have more money at the end of the 40 year period, by paying a dividend out of small business income as opposed to paying a salary. The savings range from $33,000 in P.E.I. to $66,000 in Ontario.

Dividend Tax Advantage

The numerical analyses above reflect the following:

1. There is a clear absolute income tax advantage (1.9% to 3.4% in Ontario) for corporations that pay dividends rather than salary; and

 2. Where corporate funds are not required for personal use immediately, it is best to pay the higher corporate rate and to retain the funds to be paid out later as dividends.

Bloggers Note: If you are suffering from "numbers fatigue" at this juncture, you can skip directly to the second to last paragraph. The next few paragraphs will most likely be of interest to only those born with a latent accountant gene as I get a little picky with some of John Nicola's numbers.



If you did not open the link yesterday to the article by David Milstead, which discusses John Nicola’s dividend only views, please do so now, as it provides required context for the discussion to follow.

In Milstead’s article, John Nicola provides numerical support for his suggestion that a dividend only strategy may be the way to go for incorporated professionals, if not all small business owners (he contends that the dividend strategy may not necessarily be the right approach for businesses such as manufacturing companies that are asset heavy and may be sold in the future).

I really liked the clean and simple manner in which John presented his numbers. However, I would have liked to have seen the following in John’s charts.

1. In his first scenario, Mary Wilson receives what I assume is a reasonable salary of $40,000 because she is either an employee or not an active shareholder. However, in scenario two she receives $120,000 in dividends in her capacity as a shareholder. I feel this is a bit of an “apples to oranges” comparison.

In reality, some business owners may not have a spouse, or they do not wish to have their spouse as a shareholder. In the case of certain professionals like CA’s and lawyers in Ontario, their professional statues may not allow spouses or children to become shareholders. Thus, I would have preferred to have seen an example where apples are compared to apples, for instance: 

• Scenario 1- Same as John’s scenario 1. Mary receives her $40,000 salary and John Wilson receives a salary.
• Scenario 2- Mary receives the same $40,000 salary and Mr. Wilson is remunerated by dividends.

If such a calculation is undertaken (with spendable income of $189,000 in each scenario) the following occurs:

In scenario 2, the Wilson’s end up with approximately $24,000 less in RRSP funds than in scenario 1, however, the corporate savings are larger by approximately $43,000.

John’s charts clearly depict that from an income splitting perspective, it is always better to have multiple shareholders remunerated by dividends (especially where a spouse such as Mary is not active in the business). However, in many businesses both spouses are active shareholders. Thus, again I would have preferred an “apples to apples” comparison:

• Scenario three-Mary is an active shareholder who takes the same salary as John to maximize her RRSP.
• Scenario four-both John and Mary are only compensated by dividends.

If such a calculation is undertaken with spendable income of $189,000 in each case, the following occurs:

In scenario 4, the Wilson’s end up with no RRSP instead of an RRSP of approximately $47,000 as in scenario 3, however, the corporate savings are larger in scenario 4 by approximately $67,000.

These "apples to apples" comparisons do not alter the dividend tax advantage, however, I feel they provide a fairer comparison for many real life situations.

2. This may be a bit of a red herring, but in John’s chart, there is no mention of the future income tax liability related to the $54,100 in deferred corporate savings maintained in the corporation ($192,500 in scenario #2 minus $138,400 in scenario #1). Granted, I think John assumes that the funds will be left in the corporation indefinitely. However, since the income tax on these deferred earnings could be as high as 36% (at the super rate), depending upon the marginal income tax level of Mr. Wilson & Mrs. Wilson at the time they remove these excess funds, I think readers need to be aware of this potential income tax liability.

I will not debate John’s and Jamie’s conclusions that utilizing a dividend only strategy and keeping the deferred tax savings in your company will result in an overall income tax saving. However, the quantum of savings is subject to each individual personal circumstance, the number of years the funds are left in the company, the rate of return and whether the shareholder(s) are disciplined enough to keep their hands out of the holding company cookie jar.

Tomorrow, I look at why you may not want to employ a dividend only strategy.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts 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. Please note the blog post is time sensitive and subject to changes in legislation or law.