I received a couple tax related questions this week that I thought would be useful for everyone to read.
The first question was from Paul. He is curious about how dividends are taxed and how effective his dividend strategy would be. Here is the question:
a) is income from a Canadian income trust taxed differently than dividend
b) can you really receive up to 57K in dividend income as a couple and not
get taxed on it. That just seems too good to be true.
The reason I ask is, I currently live in Toronto and I’m planning on moving to Peterborough, Ontario and buying a house with my girlfriend who lives there. We are looking at purchasing a new house in Peterborough for $455,000.00 With the sale of my house and the sale of her house we should be able to put about $400,000.00 down on the new house. I am considering decreasing the amount of our down payment and investing in a dividend paying stock which I hope might cover most of the monthly mortgage payment. If we put 200k down on the house and invested in a stock with the other 200k things might work out but only if…
1) the stock (or income trust/fund) pays a 10% dividend.
2) the dividend income is not taxed.
I am presently looking at the Noranda Income Fund as a possible source for
Lets start with question A. The quick answer is yes, income trust distributions are different than dividend distributions. How so? It depends on the income trust itself, but typically an income trust distribution will include return of capital, dividends and interest. Remember, the point of an income trust is to pass on the income that they receive onto the share holder. Thus the reason why most of their distribution are taxed as income.
If you’re contemplating between an income trust or a dividend paying stock outside of a tax deferred account, it is most likely that the dividend paying stock will be more tax efficient providing that the income trust doesn’t have a huge portion in return of capital.
To answer question B, it’s not as simple as getting $57k in tax free dividends in Ontario. I’ve written about how to optimize dividend income tax before and the table indicated in the article is the maximum that you can earn INCLUDING your regular income to keep your dividends tax free. In addition, looking back at the table, alternative minimum tax (AMT) isn’t included in the calculations. Chances are, if you already have a decent salary to afford a $400,000 house, then you will most likely pay tax on the dividends received in a taxable account. I would suggest that you run your numbers through a tax calculator to see what kind of tax you would face.
With that clarified, there are many holes to the strategy indicated in the question. To begin, investing half of your home value on ONE income trust would be a mistake (IMO). Income trusts are well known for paying out more in distributions and are very volatile. What would happen if the income trust decided to stop distributions? Could you sleep at night knowing that your $200k is all of the sudden worth $100k or less? If income is what you are looking for, then perhaps look at income based ETF’s which purchase strong companies like XDV, CDZ or even XRE.
With that said though, 2009 may be a good time to jump into equities for the long term.
I know that the MDJ community is itching to chime in.. go ahead, what are your thoughts?If you would like to read more articles like this, you can sign up for my free weekly money tips newsletter below (we will never spam you).