Many of our clients have corporations that pay dividends to family members. One aspect that is confusing is that the amount of dividend upon which they appear to be taxed exceeds what was actually received. In fact, we are often accused of miscalculating the dividend. However, this is the result of the peculiar method for taxation of dividend income.
Take, for example, a dividend of $10,000 and assume the shareholder otherwise has a salary of $45,000 and resides in Nova Scotia. The tax on the salary works out to be roughly $8,525 in Nova Scotia. (It would be $6,802 in Ontario, but that is a story for another day.) The $10,000 dividend appears on the T5 slip as $11,700 since it is designed to reflect the corporate pre-tax income upon which the dividend was paid. This amount gets added to taxable income on the personal return, resulting in $56,700 as opposed to $55,000 as expected. One would expect the additional $10,000 dividend to result in an extra $4,131 of tax, but it results in only $2,511 of extra tax. The difference is $1,620, which is the dividend tax credit designed to equal the tax the corporation already paid, thus avoiding double taxation.
Put another way, the tax rate on the $10,000 dividend is 25.1%. This compares favourably to 35.3% on salary, but remember that the corporation also pays tax on its income before it can pay out the dividend. When you combine the corporate tax and personal tax on dividends, the overall tax rate is essentially the same as that of a salary. We consider many aspects when determining a salary-dividend mix. It was advantageous in the past to use dividends as the primary form of remuneration. However, tax rate changes now make the decision more complex, and salary should be considered as a viable option depending on the circumstances.
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