Yesterday’s article explained the basics of the taxation of private Canadian corporations. Today, we’ll go through a couple of scenarios to see the tax implications of withdrawing money from the corporation.
Scenario 1: Say that Jim from Newfoundland had a private incorporated business that made $10k/yr. Jim also makes $65k/yr in his regular job.
If the money was kept as a sole proprietorship, Jim would have to pay 38% on his business income.
If held in a corporation, he would only have to pay 16.0% on the business income. However, if he wanted to withdraw the money for personal use, there would be additional tax on his personal income tax.
- If the $10k business income is distributed to Jim via salary, the corporation would get a tax deduction, but the income would be added to Jim’s existing $65k job income. This would result in net tax of 38% on business income.
- If the $10k is distributed to Jim via dividends, the money would be distributed to Jim with corporate after tax dollars, but Jim would get the dividend tax credit for private Canadian corporations (25% gross up). The personal dividend would be taxed 24.58%, but that’s after the money has already been taxed 16% via the corporation. This scenario would actually result in net tax of 41.58% on the business income.
Scenario 2: Say that Jim’s business income has grown to $65k/yr but decides to quit his day job to pursue growing his business full time. Jim needs to withdraw $30k/yr to cover his personal expenses.
- If the business was held as a sole proprietorship the $65k/yr would be taxed at an average rate of 30.30%.
- If the small business was under a corporation, and only $30k was withdrawn as salary, $35k of the business income would be taxed 16%, and $30k of the salary would be taxed 21.61% including CPP/EI. The net taxation on the annual income would be: 18.5%
- What if the money was withdrawn as dividends? In that case, the whole $65k would face the 16% corporate tax, with the $30k personal dividend facing 4.35% in tax. The net taxation on the annual income would be: $11706/$65000= ~18%
As you can see from the scenarios above, whether you withdraw from your corporation in the form of salary or dividends, it works out to be approximately the same taxation.
If going with the private corporation full time, it may be preferred to take a salary as it will provide RRSP contribution room. In terms of taxation, the biggest benefit of holding a private corporation is for the tax deferral and the capital gains exemption if the company is sold.
Please note that i’m not an accountant or tax professional. Use the information above at your own risk.