In my last blog post, I introduced the wild world of corporate taxes, illustrating how an Ontario business owner could end up paying only 15% in combined federal and provincial corporate taxes. If this amount seems low to you, fear not. The government has a way of making sure everyone pays their relative due by having corporate shareholders perform personal and corporate tax integration.
Big picture, here’s the end goal: Once a corporation’s after-tax business income is distributed to its shareholders and personal taxes are paid on the proceeds, each taxpayer’s combined corporate and personal taxes should come out about the same as if he or she were a “regular” taxpayer. Admittedly, the results ain’t always perfect, but they usually come pretty close.
Would you like to see how this sausage gets made? Let’s grind out the calculations.
We’ll begin by assuming that our sample taxpayers are in Ontario’s highest marginal 2016 tax bracket. That is, they’ve already exceeded $220,000 in other income, so the dollars illustrated here are in addition to that. This makes the math a little easier. In this context, let’s compare an individual earning an additional $100,000 of personal income, versus someone who’s received an extra $85,000 through a non-eligible corporate dividend. (I’ll explain in a moment why, tax-wise, these are comparable figures.)
Scenario 1: Income earned personally
In Ontario, a taxpayer in the top 2016 tax bracket would pay 53.53% in taxes on any additional income. In our example, the $100,000 of income earned personally by an individual would incur $53,530 of taxes, leaving the taxpayer with $46,470 of after-tax cash. Pretty simple.
Income earned personally
| General formula | Amount | Calculation |
|---|---|---|
| Personal income | $100,000 | |
| Deduct: Personal tax payable | ($53,530) | $100,000 × 53.53% (Ontario) |
| Equals: After-tax cash | $46,470 | $100,000 - $53,530 |
Source: KPMG 2016 Personal Tax Rates
Scenario 2: Income earned through a corporation
As we reviewed in my last blog post, active business income eligible for the small business deduction is levied federal taxes of 10.5%. In Ontario, the combined federal and provincial corporate tax rate is 15% (or $15,000 on $100,000 of active business income). The after-tax business income of $85,000 can then be distributed to shareholders as a non-eligible dividend, which is taxed in their hands. A few adjustments are required to ensure the business owner is no better or worse off than if they had earned the income personally.
Totally grossed up
Once the dividend has been distributed to the shareholder, it must be grossed-up before being taxed. The gross-up is 17% for non-eligible dividends.
In our example, 17% of $85,000 is $14,450. These amounts are then added together to equal the taxable dividend of $99,450. (See what I mean about how $85,000 in non-eligible distributions approximately equals $100,000 of personal income?) Personal income taxes of 53.53% are then levied on the taxable dividend amount, resulting in a tax bill of $53,236.
Giving credit where credit is due
If we stopped right there, the corporate business owner would pay combined corporate and personal taxes of $68,236 ($15,000 corporate + $53,236 individual). Whoa, that’s significantly higher than the $53,530 of taxes payable by the individual in Scenario 1.
No fair! Luckily, federal and provincial dividend tax credits come to the rescue to help offset the corporate taxes already paid.
First, there’s a federal dividend tax credit for non-eligible dividends. In 2016, that was 10.5217% of the grossed up personal income: $99,450 x 10.5217% = $10,464 credit.
Then there’s the Ontario dividend tax credit for non-eligible dividends, which was 4.2863% in 2016: $99,450 x 4.2863% = $4,263 credit.
Combined, you get $10,464 + $4,263 = $14,727 in credits, which is mighty similar to the $15,000 of corporate income taxes already levied. After deducting these dividend credits from the personal taxes payable of $53,236, we end up with net personal taxes of $38,509.
Corporate personal combo
Our sausage-making is nearly complete: $15,000 of corporate taxes paid plus $38,509 of personal taxes due equals $53,509, with $46,491 of after-tax cash to stash. Voila! That’s almost identical to the $53,530 of personal taxes and $46,470 in remaining cash from our Scenario 1 taxpayer. Believe it or not, there’s usually a method to all that tax-planning madness.
Here’s a summary of the results.
Income earned through a corporation
| General Formula | Amount | Calculation |
|---|---|---|
| Active business income | $100,000 | |
| Deduct: Corporate tax payable | ($15,000) | $100,000 × 15% (Federal + Ontario) |
| Equals: After-tax business income | $85,000 | $100,000 - $15,000 |
| Dividend distributed to shareholder | $85,000 | |
| Add: Dividend gross-up (17% non-eligible dividend rate) | $14,450 | $85,000 × 17% |
| Equals: Taxable dividend | $99,450 | $85,000 + $14,450 |
| Deduct: Personal tax payable | ($53,236) | $99,450 × 53.53% (Federal + Ontario) |
| Add: Federal dividend tax credit | $10,464 | $99,450 × 10.5217% (Federal) |
| Add: Provincial dividend tax credit | $4,263 | $99,450 × 4.2863% (Ontario) |
| Equals: Net personal tax payable | ($38,509) | $53,236 - $10,464 - $4,263 |
| Equals: After-tax cash | $46,491 | $100,000 - $15,000 - $38,509 |
Sources: KPMG 2016 Corporate Tax Rates, KPMG 2016 Personal Tax Rates
That was some fun, huh? Today’s post was all about earnings distributed to shareholders. What about those earnings that you put to work generating interest income within your corporation? These are also typically integrated, to level the playing field between business owners and individual taxpayers. In my next post, I’ll show you how that’s done.
Appendix: 2016 Provincial/Territorial Personal and Corporate Tax Integration
Example: $100,000 of active business income eligible for the small business deduction| Province or territory | Top marginal tax rate (%) | Top non-eligible dividend rate (%) | Tax rate on small business active income (%) | Corporate savings or (cost) |
|---|---|---|---|---|
| Alberta | 48.00% | 40.24% | 13.50% | ($313) |
| British Columbia | 47.70% | 40.61% | 13.00% | ($630) |
| Manitoba | 50.40% | 45.74% | 10.50% | ($1,038) |
| New Brunswick | 53.30% | 45.81% | 14.12% | ($164) |
| Newfoundland and Labrador | 49.80% | 41.86% | 13.50% | $91 |
| Northwest Territories | 47.05% | 35.72% | 14.50% | $2,011 |
| Nova Scotia | 54.00% | 46.97% | 13.50% | ($132) |
| Nunavut | 44.50% | 36.35% | 14.50% | ($1,079) |
| Ontario | 53.53% | 45.30% | 15.00% | $21 |
| Prince Edward Island | 51.37% | 43.87% | 15.00% | ($917) |
| Saskatchewan | 48.00% | 39.91% | 12.50% | $579 |
| Yukon | 48.00% | 40.17% | 13.50% | ($252) |
Sources: KPMG 2016 Corporate Tax Rates, KPMG 2016 Personal Tax Rates
Hi Justin,
Nice post. A couple details that may be of importance in Ontario, if I understand them correctly: The $100,000 “extra” salary will attract another $900 tax from the Ontario Health Premium. Also, the company will by subject to up to 1.95% of tax from the Employer Health Tax.
@Dave: Thanks! The Ontario Health Premium maxes out at $200,600 of income (in 2016), so the $900 tax would be a one-time cost and payable on the initial $220,000 (which is the point where the taxpayer is bumped into the highest marginal tax bracket of 53.53%). The additional $100,000 of income would not be subject to another $900 tax.
The Employer Health Tax (Ontario) would only apply to businesses with over $450,000 of annual remuneration paid to employees (so many small businesses may be exempt from this tax, or it may be minimal).
Really like the way you broke this down. Any thoughts about doing something similar with regards to eligible dividends from publicly traded Canadian companies vs regular income? The tax integration seems to work in much the same way. I find many folks see eligible dividends as tax free or tax advantaged but when you do the math as you have done here, it is clear that any advantage is illusory.
Cheers
@Garth: I am planning to write a blog on the taxation of eligible dividends (from publicly-traded Canadian companies) in a corporation. There is certainly a misunderstanding that eligible dividends are not taxable at low income levels (when in fact, the corporation is the one paying the required taxes).
…patiently waiting for your article about taxation of eligible dividends. It is a topic that needs some clarity…
@Garth: I’ve put the corporate taxation articles on the back-burner for now, until more information is released on exactly how the figures will flow through the corporate tax return.
Thanks Justin for this very helpful article!
In the case of a business owner who has the option to withdraw that $100,000 in personal income as payroll (T4) income from the business, should the above calculation also consider the 15,000 ($100,000 × 15% ) in tax saved for the corporation by deducting the payroll as a business expense? Hope I’m not missing the logic :)
@Silva: The payroll deduction would be applied before the corporate taxes of 15% (salary is paid before taxes while dividends are paid after taxes). After the deduction, the corporation would have $0 of after-tax income, and the employee would have $100,000 of taxable income.
Hi Justin, Thanks for this cool series. Very nice. Looking forward to the next posts. I have been referring friends to your site as well as Dan’s. I will now be referring my business friends to this series as well. Thanks again
@ajb: You’re very welcome – thank you for reading our posts and referring your friends!
Justin,
Thank you so much for doing a series on corporate taxation. This will be highly beneficial for professionals and business owners.
In your example, the person is paid through dividends. Is the tax integration as perfect with a person paid in ‘salary’?
My wish list for the future posts on the subject would be:
1) The ideal asset class in priority to hold in a CCPC tax-efficiency-wise: Canadian equities vs US vs Int vs bonds vs GICs.
2) Where to put money first when you have extra savings: CCPC vs TFSA vs RRSP.
3) Is it even worth it to have an RRSP or TFSA when you have a CCPC?
Thanks so much Justin. Keep up the good work!
D
@D: The comparisons in this post are very similar to the salary vs. dividends question (just think of the $100,000 of additional income in scenario 1 as additional “salary” income and scenario 2 as dividend income).
Once we’ve discussed the taxation of different types of investment income, that should help you make more informed decisions regarding your question #1 (there is no perfect solution for everyone, but there are general mistakes that can be avoided). Questions #2 and #3 in your wish list have already been answered by Jamie Golombek:
http://www.jamiegolombek.com/media/TFSAs-for-Business-Owners-EN.PDF
https://www.cibc.com/content/dam/small_business/advice_centre/business-reports/RRSPs-for-business-owners-en.pdf
Why is Quebec not included in the table? Are the rules that different?
@Kevin: The tax program I was using to double-check the calculations did not include the Quebec tax return, so I excluded the province. The calculations are similar – I would estimate a corporate cost of about $920 on $100,000 of additional income.