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Business owners need to decide whether to take any investment income they earned as dividends

If you have an incorporated business with a Dec. 31 year-end that earned investment income in you need to make a decision as to whether you leave the money in your corporation or pay it out as a dividend.

By way of background, let’s take a look at the perennial question of whether an incorporated business should leave surplus after-tax business income in the corporation or distribute the funds as dividends or bonuses. For active business income up to the small business deduction limit ($ federally and in most provinces), there is a significant tax deferral advantage that ranges from 25% to 36%, depending on the province. For active business income exceeding the small business deduction limit, the tax deferral advantage is slightly lower and ranges from 13% to 23%. This means that by leaving after-tax business income in your corporation, there is more money that can be invested than if you were to withdraw the funds from your corporation and invest them personally.

If you’re a business owner who has left surplus funds in your corporation, now is the time to look at the taxes that arise when the corporate funds are invested and what to do with the funds that remain after taxes are paid on the investment income.

The amount of taxes paid when it comes to earning investment income inside your corporation depends on the type of income earned, such as interest income, Canadian dividends or capital gains. Similarly, the amount you get to keep will depend on how well the corporate tax system is “integrated” with the personal tax rates in your province of residence.

Based on my analysis, there is an investment advantage for most types of investment income in An investment advantage occurs when the after-tax investment income that is available by retaining funds in your corporation is greater than the after-tax investment income that is available by distributing funds to yourself as a dividend. When there is an investment advantage, it is better to retain after-tax investment income in your corporation since there will be a greater amount for re-investment.

Conversely, if there is an investment disadvantage, less after-tax investment income is available to your corporation, so you should distribute the after-tax investment income as dividends in the year it is earned and re-invest the resultant after-tax funds personally. Accordingly, if you do not need funds personally, after-tax corporately earned interest income, capital gains and dividends should generally be retained in your corporation, with a few exceptions. For a full summary of the details for your province of residence, please see my report In Good Company: Retaining investment income in your corporation.

THE AMOUNT OF TAXES PAID WHEN IT COMES

TO EARNING INVESTMENT

INCOME INSIDE YOUR CORPORATION DEPENDS ON THE TYPE OF INCOME EARNED