bag-dividends

The expert

Wilmot George Jr.

Wilmot George Jr., CFP, TEP, CHS, director of tax and estate planning at Mackenzie Investments, Toronto

Client profile

Roshni Mehta, 29, owns a driving range and mini-putt facility in Brantford, Ont. Three years ago, she added a high-tech indoor swing analysis and club fitting centre to attract golfers during the winter. The added profit has pushed her into the highest tax bracket.

She wants to pull an additional $10,000 per year from her business to fund a lifestyle upgrade, but doesn’t know how to avoid a tax hit. Should she take dividends in lieu of salary or bonus? She read about Budget 2013’s changes to the small business dividend tax credit and is wondering how they’ll affect her.

In 2013, it was generally more tax-efficient to earn business income as non-eligible corporate dividends everywhere but Quebec and P.E.I.

After the proposed changes, however, it will be more tax-efficient to earn business income as regular income in six out of 10 Canadian provinces.


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Degree of difficulty

7 out of 10. George suggests advisors leave the number crunching to accountants. Instead, your key role is to help a client decide whether to go with dividends or a bonus by explaining the implications and tradeoffs for CPP benefits and income-splitting options.

The issues

Corporate income gets taxed twice: when it’s earned by the business, and again when it’s paid out as a dividend to an employee. “The purpose of the dividend tax credit (DTC) is to compensate the taxpayer for this double hit. The government’s trying to put her in the same position she’d be in had she earned the income without using a corporate structure,” explains Wilmot George, director of tax and estate planning at Mackenzie Investments in Toronto.

But “because of decreasing corporate tax rates, the DTC and gross-up factor currently applicable to small businesses, (non-eligible) dividends actually overcompensate some taxpayers,” he says.

Budget 2013 closes the gap. Effective 2014, the federal gross-up factor for non-eligible dividends falls from 25% to 18%; and the corresponding DTC will go from 13.33% to 11%. “The result is a 1.6% federal tax increase,” adds George.

Here’s how the change breaks down federally for a $10,000 dividend:

Table 1 2013 2014
Non-eligible dividend $10,000 $10,000
Gross-up $2,500 $1,800
Taxable dividend $12,500 $11,800
Federal tax (29%) $3,625 $3,422
Dividend tax credit ($1,666) ($1,298)
Net federal tax $1,959 $2,124
After-tax proceeds $8,041 $7,876
Top federal marginal tax rate 19.6% 21.2%

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