Use Your Business to Pay for Personal Tax Deductible Expenses

During my last net worth update, I wrote a little bit about our strategy on getting cash out of a privately owned corporation in a tax efficient manner.  While it’s tax efficient to have retained earnings within a corporation, the goal is to extract cash by the most tax efficient means possible.  One way to do this is to pay personal tax deductible expenses with dividends from the corporation.

I’ve actually touched on this topic before on using your business to pay for charity donations with the idea that non-eligible dividends are taxed less than the actual tax deduction.  The strategy is to arbitrage the income tax rate on the dividends, with the tax deduction on the personal expense.  The end result is that the shareholder can withdraw more in dividends than what’s required to pay the expense, and pay no tax on the withdrawal from the company.

Charity Donation Example

There’s no better way to show this than an example.  Say that Mr. Owner, from NL, typically donates $10,000 annually to his favorite charity.  Instead of using his own cash flow, he can pay himself a dividend from his company, then use the dividend cash to pay for his donation.

The donation tax credit will more than offset any income tax payable on the dividend received.   In this case, since the donation tax credit is calculated at the top marginal rate (on amounts greater than $200), there is a significant spread between the donation tax credit and the tax rate on the dividend.  This simply means that Mr. Owner is able to withdraw more out of his company via dividends than what he will pay the charity, keep the difference, all while paying no additional income tax.

How much more can he withdraw?  It depends on his overall income after the dividend withdrawal.  On the conservative side, the worst case scenario is that he is already in the top marginal tax bracket which means that that his non-eligible dividend rate is 29.96% (via taxtips).

Ready for some numbers? With the dividend tax credit calculated at the top tax rate (42.3% ) which is about 41.2% greater than the dividend tax of 29.96%, it means that the dividend withdrawn can be 41.2% greater than the charity contribution.  In this case, Mr. Owner can withdraw $14,230 from his company via dividend, donate $10,000 to his favorite charity, and keep the difference tax free.

To simplify,

Approximate dividend withdrawn from company = (Charity Donation Amount * Top marginal rate)/dividend tax rate

For charity donations, the lower the dividend tax rate/marginal tax bracket, the more effective this strategy becomes as the spread between the donation tax credit and the non eligible dividend tax increases.

RRSPs and Other Tax Deductions

For regular RRSP contributions or other tax deductible expenses, the tax refund is approximately the contribution * marginal tax rate.  In this case, the formula is:

Approximate dividend withdrawn from company = (Tax Deductible Expense * Marginal tax rate)/dividend tax rate

So say Mrs. Owner (in NL) makes an RRSP contribution of $5,000 with a marginal tax rate of 27.5% and a non-eligible dividend tax rate of 11.46%.  Using the formula, she could withdraw almost $12,000 from the corporation, deposit $5,000 into her RRSP, and keep the remaining $7,000 without paying any additional personal tax.

Note that the formulas above are an approximation as the dividend withdrawn, depending on how large, can bump the shareholder into the next bracket. This post is more of an illustration rather than a recommendation on how much to withdraw per tax deductible cost.   Best bet would be to use an online tax calculator to figure out your overall picture and determine how much in dividends that you can take out after counting all deductions.

For you business owners out there, what strategies do you use to get cash out of the corp?

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FT is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.
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Cherleen @ My Personal Finance Journey
9 years ago

I still cannot understand it. I really have difficulty understanding anything that has to do with tax or anything related to it. So frustrating.

9 years ago


Re: using a holding company for and RRSP/RESP

What about the additional taxes on investment income earned in a corporation (Additional Part I @ 26.67% on interest and taxable capital gains and Part IV @ 33.33% on dividends)?

The purpose of these taxes are to negate any benefit from holding investments in a holding corporation. You only get them back when the holdco pays out a dividend, which triggers personal tax.

I don’t see the tax benefit to holding investments in a holding company.

9 years ago

Biggest advantage of the trust over the holding company is that then the Trustee (you) gets to have complete control over who gets what out of the dividends paid to the trust. If your children are 18 years old and are shareholders of your holding company, then they do have legal right to the company and you have less control over who gets what. With the trust, you are in complete control of who receives what (or doesn’t).

9 years ago

FT, that can work too, though the trust does offer some benefits and ease of use, but you can hold your income earning corporation through another holding company and then sprinkle the dividends out of that or keep them to invest as you wish. You can then use your holding company to invest in any other corporations that you wish as well. The other advantage is if/when you sell your income earning corporation, you can share the small business capital gain allowance to all parties, not just yourself. Not a big deal if the corporation isn’t worth a lot, but if you manage to grow it and it sells for $3 million, you can split that 4 ways, $750,000 each, and get the entire amount tax free to your family.

9 years ago

Can you help me start a business so I can do this? lol

9 years ago

Ensure that you have different classes of shares in your corporation to be able to effectively dividend sprinkle. If both you and your wife own Class A common shares, when you issue a dividend, you’ll both get an equal amount (you can’t pick and choose within a single class of shares).
Alternatively, set up a family trust and then have the trust set up the corporation. Have you and your children become beneficiaries of the trust and then you can issue straight common share dividends to the trust and decide from there who gets what. Children under the age of 18 get taxed at the top rate, however, so it’s only useful for when they reach 18.
Next trick is to set up a second holding corporation as a beneficiary of the trust and then your income earning corporation can flow dividends to the trust which can then flow those dividends tax free (except for the initial corporate tax on the income earning corporation) to the beneficiary holding company. The company can then hold on to those funds and invest them as it likes. In effect, it becomes a powerful investment vehicle akin to your RRSP because it is using pre-personal tax dollars to invest.
If you’re still following this example, now you’ve got yourself the perfect RESP investing machine. Forget the after-tax dollars and small bonus from the government for a standard RESP. Let the dividends flow to the holding company, invest them there, then when your children turn 18 they can take up to $40,000 per year TAX FREE. An RESP cannot even begin to compete. There is added administrative burden, but if you’re any good at paperwork you can do it all yourself.