Have you ever wondered, “If I pay tax on income earned by my professional corporation (“PC”) and then pay tax on the income received from my PC am I not being taxed twice?” A great question with an answer that opens the door to an important tax-saving technique: optimizing your salary/dividend strategy.
Review your salary/dividend strategy to ensure the numbers work in your favor annually
Canadian income tax policy is designed to avoid double taxation in most situations. Whether a salary or a dividend is received, total tax paid at both corporate and personal levels should be the same in theory, but that doesn’t always occur because tax rates change annually.
Understanding the difference between Dividends and Salary
Example: You bought shares of a bank, meaning you’re an owner – a shareholder. As an owner, part of the bank’s profit is your profit! When the bank distributes the profit, you will receive a dividend. You earn dividends because you own shares, whereas salary is received in exchange for work performed as an employee.
Dividends and Income Protection Plans
Dividends are not subject to source deductions like CPP/EI and income tax as employment income is. So, if dividends are received from your PC, be sure to set aside a portion of the dividend for tax – 40% is a good general rule.
Access to public income protection plans like CPP and EI may be restricted when only dividend income is earned. This is because dividends are passive in nature; work is not performed to earn dividends. Social safety net programs, on the other hand, protect the income of employed and self-employed workers in the event of a catastrophe.
Private income protection insurance like long-term disability and critical illness insurance may be affected by dividends. Check with your broker to ensure that benefits will not be adversely affected by the type of remuneration received from your PC.
Dividends and Deductions
Dividends can limit access to some deductions. For example, a nanny, camp fees or babysitting are not deductible against dividend income. So, a remuneration strategy including some salary would permit child care expenses to be deducted. The same holds true for RRSPs. An annual remuneration strategy should review ongoing expenses to ensure the salary-dividend strategy takes advantage of all available deductions.
Save Tax through Income Splitting
Tax can be saved when PC income is split between no/ low-income family members. Clients often ask, “Can my PC pay my spouse a salary to raise our kids?” or “Can my PC pay my child a salary to attend university?” Unfortunately, the answer is “no” in both cases, but they can own shares and earn dividend income.
Dividend Tax Credit: Avoiding Double Tax
To return to the bank shares example, the bank earned a profit and paid tax on those profits. Now you will report income that the bank has already paid tax on.
While this may seem like double tax, it is not. When dividends are reported, a dividend tax credit may be claimed. This credit is designed to reduce your tax bill by a notional amount roughly equal to the amount of tax paid by the bank, so double tax is avoided. Integration between the bank and you is not flawless but, in theory, the dividend tax credit gives credit against your personal tax for the corporate tax that was paid upstream. It is this same mechanism at work between you and your PC that is intended to avoid double taxation.
Review your Salary/Dividend mix over the last 4 years. Is it about the same every year? If so, then you might be missing an opportunity…
Contact Jonathan Tucker for more information at (800) 845-0540 or [email protected]
 Family law and tax complications from family members who are shareholders exist so consult a family law lawyer to identify/ address issues before making family members shareholders.
 Share ownership between non-practicing family members may be prohibited by some healthcare professions. Contact your profession or our office for more information.