TORONTO—A report from CIBC says foregoing the traditional year-end bonus in favour of dividends from business income would pay off for small business owners.
The report argues against the long-held adage suggesting small business owners are better off paying themselves a bonus to reduce their business income so that it is all taxed at the lower small-business tax rates.
In many cases, a dividends-only strategy may beat the traditional year-end bonus as the preferred method of remuneration for incorporated small business owners in 2011, provided the payout is not needed in the near term for consumption by the business owner.
“In most cases, in most provinces, it makes sense to have corporate income, whether eligible for the small business deduction or not, and which is not needed to meet short-term spending needs, taxed inside the corporation rather than paid out as a bonus,” says Jamie Golombek, tax and estate planning expert at CIBC.
The Canadian income tax system is designed so individuals should be indifferent between earning income personally or through a private corporation.
The sum of the corporate small business tax and the personal tax paid by the shareholder on SBD income and paid out as dividends is less than tax otherwise payable if the corporate income was paid out as a salary and taxed at full marginal tax rates personally.
The report concludes that an even greater benefit can be achieved by reinvesting SBD income within the company, allowing for a significant tax deferral, although the business owner must ultimately pay tax when dividends are distributed.
This same theory applies to Active Business Income (ABI) not eligible for the small business deduction. It may be advisable for small businesses to have ABI taxed within the corporation and then retain the funds for reinvestment purposes, thereby capturing a valuable tax deferral advantage.