Dividends vs. Bonuses

Reading a bunch of articles on the internet, an uninformed person may make the conclusion that dividends trump wages every single time.

Although accountants would have you believe they have the magic sauce to navigate their world, their world is governed by the same laws that govern the rest of the universe: math and its marginal effects.

Once you understand this, you will understand that you can make hard categories like dividends = good and wages = bad.

Bad categorical thinking:

  • Dividends are taxed less personally than wages, anyone who takes a bonus is being wasteful” similarly bad is:
  • Dividends require you to pay tax twice – first in the company, then personally, and corporations do not enjoy an exemption amount

Good marginalist thinking:

  • “How much deductions against the corporate income?”
  • “How much personal taxes?”
  • “When does moving in one direction or the other stop being worth it?”

In the case of dividends, corporate income tax is paid on the income earned by the corporation and the dividend is paid out of the after-tax earnings. This dividend is then taxed in the shareholders’ hands which takes into account the dividend tax credit system. Starting in 2016, there was an increase in the effective tax rate on non-eligible dividends. The gross-up factor for non-eligible dividends decreases and consequently, there is a progressive decrease in the dividend tax credit. Under-integration may occur where the tax-payer is being double-taxed since they already paid tax in the corporation and now they pay personal tax on the same income.

As with all convex mathematical functions, there is only one minimal value that describes the combined taxes in terms of its variables. Our job is to find the global minimum of this function, that is, we find the point such that f(x ) < f(x) for all in the domain of the function.

Optimizing combined corporate + personal taxes depends sensitively on draws, income, and dividend-salary mix. For the sake of comparing apples and apples, and to have a reference to the article below, CPP is ignored.

$50,000 has $2,254 cash advantage to being earned as dividends vs wage

Personal T4

$50,000

Income Tax

-$11,271

Net to individual

$38,729

Corporate Income

$50,000

Small business tax @ 12%

-$6,000

Net cash retained after-tax

$44,000

Dividends payable

$44,000

Net personal tax on dividend

-$3,017

Net cash to shareholder

$40,983

$100,000 has $1,224 cash advantage to being earned as a wage vs dividends

Personal T4

$100,000

Income Tax

-23,820

Net to individual

76,180

Corporate Income

$100,000

Small business tax @ 12%

-$12,000

Net cash retained after-tax

$88,000

Dividends payable

$88,000

Net personal tax on dividend

-$13,044

Net cash to shareholder

$74,956

Click on”the link to download a great article by the Managing Director of Tax Planning at CIBC Wealth Services:dividends-bonus

Here he explains that in Alberta, in our second example there is an absolute tax rate disadvantage on paying tax at the corporate rate. In the seven provinces where there is a tax rate disadvantage on SBD income, income must be retained for a period ranging from 1 year (in British Columbia, New Brunswick or Nova Scotia) to 11 years (in Alberta) before paying a dividend at that level for savings to be realized. In the second example, income should be distributed through dividends only if the income is expected to be retained in the corporation for 11 years; otherwise, it is preferable to pay out the income as a wage.

The second, unrelated irritation I have with “the art of paperwork“, is how some accountants miraculously can reduce their clients’ personal taxes by “losing” their shareholder draws between inter-company accounts. If you have two related corporations and one corporation invests money in the 2nd venture, the due-to-related-parties in the 2nd venture should match precisely the investment in the first company. Today, the CRA employs algorithms to match these amounts on your related companies and will eventually find and review the error. Although the accounting practitioner can avoid any serious penalties (by saying it was an innocent paperwork error) the client will be reassessed and have to pay all the taxes + non-deductible interest and penalties = fake accomplishment. Accounting is a beautiful series of debits and credits which must balance.

Make no mistake, these people are cheating their customers. The client signs all the paperwork saying they take responsibility for the reported numbers. We parted ways with one well-known client who was not happy with paying her fair share, only to get an email from this same firm afterward, birds of the same feather flock together.

Any inconvenience you may have suffered can be turned into a learning experience and the future just gets better:

  1. The money you can make back, but the time you can never, so if you are going to work, then hone your hard-to-replicate skills.
  2. Prioritize learning and honesty which builds goodwill and is manifested in referrals and a lifetime of abundance. The inverse of prioritizing earning will ultimately lose you the customer.
  3. Manage your business on a yearly basis, rather than quarterly or monthly. Spend your time doing what you do. Operate on 5-year plans. We focus on doing the right thing each day and creating value for our clients. Most people focus on short-term gains and the expense of building long-term value.
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