Owners of corporations have always had many choices to make in order to try to minimize their total tax burden. Salary versus dividends, RRSP contributions versus retained earnings, and income splitting with family members are just a few of the decision points.
“Integration” is the tax concept that whether a business owner incorporates and pays corporate tax (then individual tax on dividends to get the money out of the corporation), or earns all of the income personally, taxes should be similar.
Depending on changing tax rules, there are times when one method has worked better. Planning has gone full circle over the past 10 or so years, and now the election results will make planning even more challenging. We are here to help.
A reminder, though, that all such planning and decision making should be made in discussion with your tax advisors, before you make decisions or write cheques. My comments here will help you understand the concepts and considerations, but please don’t take this as advice for your situation.
In the “old days”, the planning was fairly automatic for a profitable, closely-held corporations. The company would pay salaries or bonuses to reduce company profit to the small business deduction (SBD) limit, currently $425,000 in Manitoba (rising to $450,000 in 2016), since any higher profits would be subject to the high general corporate tax rate.
Below that, the federal small business tax rate of 11% applies to active business income, and there is no Manitoba tax. Above $425,000 of net profit, MB tax jumps from zero to 12%, and federal tax becomes 15% above $500,000 of annual profit.
Passive investment income earned by a corporation - typically an investment holding company or “holdco” - is taxed at 46.7%, though lower for eligible dividends received. This high rate encourages holdcos to pay out profits to be taxed in the shareholders’ hands, rather than pay high rate tax on profits still trapped in the corporation.
This approach would also have the owner’s salary be at least $140,944 to allow the maximum RRSP contribution of $25,370 for 2016. CPP contributions are maximized at $53,600 of income. Both employer and employee have to contribute 4.95% of that salary, to a max of $4,900 combined. Keep that figure in mind, as it is a cost that can be avoided, if you are willing to forgo CPP.
The top combined individual tax rate on salaries in Manitoba is 46.4%, but this is only payable on income in excess of $138,586. (Expect higher rates next year federally on income over $200,000.)
My National Bank Financial colleague Cedric Paquin, CPA, CA, CFP has shown me that currently, there is a tax cost to being incorporated, once personal tax on the non-eligible dividend (NED) is factored in, partly because in 2013 Manitoba raised the effective rate on NEDs. The federal Conservatives’ planned decrease of the corporate small business tax rate has the ironic effect of increasing the tax cost for incorporation, as it effectively decreases the dividend tax credit on NEDs.
This has prompted some tax advisors to suggest paying extra dividends in 2015, especially from holdcos, to pay less tax on dividends than in the future. However, the new Liberal government may cut back on the tax cut, and negate this need.
There is still a tax deferral advantage on money left in the corporation and paid out in the future. This is the case when not all income is needed to fund current living expenses. The more time to that future, the bigger the potential advantage.
Deferral of up 35.4% of income is possible on the first $425,000 of profit, and 19.4% on corporate income above that. If the Conservative’s planned cuts come through, this deferral advantage widens over the next few years. However, tax rates on NEDs will be higher, as an offset.
Other shareholders have found that by paying no salaries or bonuses, and instead splitting dividend income between spouses or other adult family members (thus paying personal taxes at much lower rates), they can achieve significant outright tax savings compared to the old thinking, if they keep their income needs moderate. They forgo CPP and RRSP contributions, use TFSAs and the corporation itself for retirement accumulations instead, and pay less tax now and in the future.
Cedric and I have fun crunching such numbers for clients, to determine the best case for each.
That’s a big part of financial planning. If you earn income through a corporation, or have the opportunity to, be sure to get your tax advisor to give you all the options.
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Dollars and Sense is meant as an introduction to this topic and should not in any way be construed as a replacement for personalized professional advice.
Please consult legal, tax, insurance and investment experts for advice on your unique situation.
David Christianson, BA, CFP, R.F.P., TEP, CIM is a financial planner and advisor with Christianson Wealth Advisors, a Vice President with National Bank Financial Wealth Management, and author of the book Managing the Bull, A No-Nonsense Guide to Personal Finance.