# Taxation of private corporation dividends - how does it work?



## Electric (Jul 19, 2013)

Say I have earned income from a day job of $I. And I am a shareholder/principal of a non-public engineering consulting company, from which I get dividends of $D. I, and the company, are domiciled in Ontario.

1. Is my income tax bracket based on I, or (I+D)?

2. Does the dividend tax rate depend only on I, or (I+D)?


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## 0xCC (Jan 5, 2012)

I am not a tax expert but I think that neither of your cases applies. I *think* your tax bracket is based on I + D + dividend gross-up amount. It doesn't really matter anyway (other than for bragging rights I guess) since you will only pay tax on your income I based on the tax bracket you are in (and only the portion of that income that is over the limit for the previous tax bracket will be subject to the tax at the tax rate of that bracket, not all of the income). For example, for 2014 in Ontario if you made $43,954 you would pay 31.15% income tax on the $1 that is over $43,953 (based on 2014 tax rates here: http://www.taxtips.ca/taxrates/on.htm) and 24.15% for the portion of income from $40,120 to $43,953 and 20.05% on the first $40,120.

As for the dividend parts, you can think of them as being income sitting on top of your other income but they also get "grossed up" by 38% (I think) so every $1 in dividend income increases your income by $1.38. Then you get a dividend tax credit based on the grossed-up amount that is used to take off the top of the tax you owe. The part that I am a little fuzzy on is when the grossed up dividend amount bumps you into another tax bracket. Do you end up paying a higher tax rate on your dividends even though you didn't really have the "grossed-up" amount in your pocket? I think the answer is yes but I am not totally sure about that.

Finally, you are discussing private corporation dividends. The question then is whether the dividends are eligible dividends or not. This is CRA's page on the issue:
http://www.cra-arc.gc.ca/eligibledividends/ 

The difference between eligible and non-eligible dividends is what the gross-up amount is and how big the dividend tax credit is. In any case the taxtips.ca tax brackets linked to above give the amount of tax that needs to be paid on the actual amount of both eligible and non-eligible dividends. Again, I am not totally sure what happens when the grossed up amount pushes you over a tax bracket. You should be able to use the tax calculator on taxtips.ca to figure out what happens (or do a mock tax return in your tax preparation software of your choice and play around with the dividend amounts so that the non-grossed up amount of dividends brings the taxable income up to the top of one tax bracket and then again so the grossed up amount brings taxable income up to the top of a tax bracket).

Anyway, I am not a tax expert and I don't play one on the internet. This is my own opinion and since I don't have any money on the line here you should value this information as much as you have paid for it (which is exactly $0 ).


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## Electric (Jul 19, 2013)

Hmm. I have done more investigation, and am only slightly less confused. This is the situation, all incomes in Ontario:

Person A: employment income of $X k.
Person B (spouse of Person A): employment income of $(X/2)k.
Person A consults and earns $(X/4)k.

So the choices are, Person A accepts the consulting income directly and pays tax on $(*1.25X*). Tax bill is $(X/3). Net income for the couple in this case is *about 1.25X* after Person B pays (X/6) in tax.

Or, a corporation is formed which earns the income, and a non-eligible dividend is issued to Person B in the amount of $(X/8) (after 11%+4.5% small business corporate tax is deducted). In this case, the net income for the couple is *very close to 1.25X*.

So, the incorporation gain is not high, even if you ignore legal and accounting expenses associated with forming a corporation and filing appropriate tax returns. But this is contrary to the informal advice I am getting from others.


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## WiseOwl (Jan 1, 2015)

I sent you links to help you understand the concept behind considering whether to incorporate or not.

0xCC was correct in that your income is I (employment income from day job) + D (ACTUAL amount of dividend) + DGU (dividend gross-up). Dividend gross-up factor will depend on whether or not the dividend declared was "eligible" or "other than eligible". This is a complicated topic as it leads in to the concept of integration and whether corporate income earned was taxed at the small business rate (aka low rate) or general rate (aka high rate). This is a very high-level and generic discussion...suffice to say, most small businesses would be declaring "other than eligible" dividends assuming their income was below $500k and they do not receive any eligible dividend investment income. Ability to pay eligible dividends is tracked in a tax pool known as "GRIP" which stands for "General Rate Income Pool".

The dividend gross up rate for other than eligible dividends is 18% in 2014. That is, if you declared a corporate dividend of $35,500 for example, your grossed-up dividend would be $41,890. The $41,890 is added to your personal income. The dividend tax credit would be $4,615. The dividend tax credit is not in any way related to any of your other income. It's a straight mechanical calculation of 13% of the actual dividend.


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## Electric (Jul 19, 2013)

Thanks to both. I have a tax accountant coming over tonight to go over it with me.

Right now, it seems like the gains aren't there to go through the annual small business tax process, and there is the whole issue of the personal services business classification.


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## FrugalTrader (Oct 13, 2008)

What we do is use a tax calculator and punch in the numbers to see how it affects our overall tax picture. You can play around with the dividend numbers to see how much personal tax you'll end up paying after RRSP refunds etc.

http://www.taxtips.ca/calculators/canadian-tax/canadian-tax-calculator.htm


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## Electric (Jul 19, 2013)

Thanks, FT, I had been using the tax tips website to generate the estimates above. It is very useful for sure.

I had a surprisingly short chat with our accountant tonight. It seems that in addition to the gains of incorporation being quite small, there is about $1000 worth of accounting that has to be done every year to make a business return. This goes on more or less forever, even after the corporation is no longer producing active income.

There is some risk of losing the small business deduction, and being classified as a personal services business. This can happen retroactively, so it can work for a while until it doesn't one year and you have to pay a lot of interest.

I am sure I could find an accountant who would give me contrary advice, but until we get to a point where there some employees and more than one source of income, I think incorporating is a nonstarter.


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