Most incorporated business owners hit a moment where they realize something uncomfortable.
The money is there. The corporation has been profitable for years. Retained earnings have built up. But every time they try to take money out, the tax bill is enormous. So the money just sits there. Growing. Getting taxed again on its investment returns. And quietly creating a problem that gets harder to solve the longer you wait.
If you are incorporated and profits have been building up inside your corporation, this post is for you. I am going to walk you through every strategy available — from the straightforward extraction tools most people know about, to the two strategies that solve the problems none of those tools can.
The Retained Earnings Trap
Your corporation earns active business income and pays a low corporate tax rate. In Ontario, that rate is approximately 12.2% on the first $500,000 of active business income. That is the Small Business Deduction, or SBD. It is one of the biggest financial advantages of incorporating.
So you leave profits inside the corporation and invest them. The portfolio grows. This feels responsible.
But here is what most people do not realize. Once your corporation earns more than $50,000 of passive investment income in a year, the government starts clawing back your access to that 12.2% rate. This is called the Small Business Deduction grind.
For every dollar of passive income above $50,000, your SBD limit gets reduced by five dollars. By the time passive income reaches $150,000, your SBD is gone entirely. Your active business income is now taxed at 26.5% instead of 12.2%. More than double.
The retained earnings you built up are now costing you money on every dollar the business earns. That is the trap.
The 7 Ways to Extract Money
There is no single right answer. The best approach depends on your age, your income needs, your family situation, and your long-term goals. Here is a plain-language overview of every tool available.
1. Salary and Bonus
You pay yourself a salary or year-end bonus. The corporation deducts it. You pay personal income tax up to 53.5% in Ontario. It creates RRSP room. It works well for regular living income but gets expensive fast when trying to extract large retained earnings balances.
2. Salary Income Splitting with Family Members
If your spouse, adult children, or other family members genuinely work in the business, you can pay them a reasonable salary for their contributions. Employment income is completely outside the Tax on Split Income rules — TOSI — which makes this one of the cleanest income splitting strategies available.
Three conditions apply. The salary must be reasonable for the role — comparable to what you would pay an arm’s length employee for the same work. The family member must actually be performing the work. And the corporation must issue a T4 and remit source deductions as it would for any employee.
Minor children can also participate in this strategy, provided the salary is reasonable for the work actually performed and properly documented. TOSI does not apply to employment income — it targets passive income splitting, not genuine employment arrangements. And unlike dividends, the attribution rules do not apply to salary paid to a minor for actual work, as long as the salary is deductible to the corporation and included in the minor’s income. Keep timesheets, job descriptions, and payment records to support the arrangement.
3. Dividends
The corporation declares a dividend and pays it to shareholders at reduced personal tax rates. Not deductible to the corporation, but the dividend tax credit makes them more tax-efficient than salary at higher income levels.
The limitation on dividend splitting is significant. Dividends paid to family members who are not active in the business are subject to the Tax on Split Income rules — TOSI — and taxed at the highest marginal rate regardless of the recipient’s actual income. This eliminates most family dividend splitting.
However, there is an important exception. If a family member is 18 or older and works at least an average of 20 hours per week in the business — either in the current year or in any five prior taxation years — their dividends qualify as income from an “excluded business” under subsection 120.4(1) of the Income Tax Act. In that case, TOSI does not apply and there is no cap on the amount of dividends they can receive. A working adult child or spouse who genuinely contributes to the business can receive meaningful dividends without TOSI scrutiny — provided the 20-hour threshold is genuinely met and properly documented.
4. Capital Dividends
When your corporation sells a capital property, the non-taxable half of the capital gain flows into the Capital Dividend Account — the CDA. You can pay that balance to shareholders completely tax-free. This requires a formal election with CRA using Form T2054. Pay more than your CDA balance and a 60% penalty tax applies to the excess. Get this one exactly right.
5. Repayment of Shareholder Loans
If you ever loaned your own money to the corporation, it owes you that money back. When it repays you, it is tax-free. You are simply recovering capital you already owned. The limit: you can only get back what you put in.
6. Individual Pension Plan
An IPP is a defined benefit pension plan set up by the corporation specifically for the business owner. Contributions are tax-deductible to the corporation and larger than RRSP limits allow — especially for owners over 40. Money grows tax-sheltered. Requires professional setup including an actuary.
7. Selling Personally Owned Assets to the Corporation
Think of it this way. You have a right pocket and a left pocket. Your right pocket is you personally. Your left pocket is your corporation. Right now, your personally owned assets are sitting in your right pocket, and a pile of retained earnings is sitting in your left pocket.
This strategy lets you sell assets from your right pocket to your left pocket. The corporation — your left pocket — now owes you the purchase price. It pays you that money. Cash moves from the corporation to your personal hands.
Done properly, you can move a significant amount of retained earnings from the corporation to your personal name with little to no immediate tax. If you have a large amount of personally owned assets and a large pool of retained earnings sitting in the corporation, this can be a powerful tool to close that gap.
The technical mechanism is Section 85 of the Income Tax Act, which allows you and the corporation to jointly elect a transfer price near your original cost — deferring the capital gain rather than triggering it immediately. The gain does not disappear. It stays inside the corporation to be dealt with later. But in the meantime, you have extracted cash personally. This is technical and requires both an accountant and a lawyer to execute properly.
The Problem These Seven Strategies Cannot Solve
Every strategy above extracts money. Some more efficiently than others. But they all share the same fundamental limitation.
None of them solve what happens when you die.
When a business owner dies holding shares of a private corporation, those shares are deemed disposed of at fair market value. That triggers a capital gain on the full appreciation. The estate pays tax on that gain. Then when the corporate assets are paid out to the family, they are taxed again as dividends. The same pool of money gets taxed twice. This is the double taxation problem at death.
And on top of that, the SBD grind keeps applying every year while the business is still running. Retained earnings keep building. The investment portfolio keeps generating passive income. The seven strategies above can slow that problem. But they cannot stop it.
That is where the insurance strategies come in.
The Two Strategies That Solve What the Others Cannot
These two strategies sit in a different category from everything above. They are not extraction tools. They are planning tools — and they address the problems that extraction alone cannot fix.
Leveraged Segregated Funds: Protecting Your Small Business Tax Rate
The corporation borrows money and invests the proceeds in segregated funds — insurance-based investment products offered by insurance companies. Think of them as a version of mutual funds, but with a built-in guarantee on your principal or death benefit. You can invest in index-based strategies inside a seg fund — similar exposure to what you might get from a regular ETF — but with that insurance wrapper around it.
That guarantee is not just a nice feature. It is what makes the borrowing possible. A bank will not lend you money to invest in a regular mutual fund or ETF because there is nothing protecting the collateral value if markets drop. With a seg fund, the guarantee protects the lender. That is why the financing is available in the first place. The higher fees you pay for seg funds are essentially the price of that guarantee — and the guarantee is what unlocks the strategy.
Two things then work together to reduce the passive income that triggers the SBD grind. First, the interest on the borrowed money is tax-deductible, which directly reduces net passive income. Second, seg fund returns are treated as capital gains when units are sold — and only 50% of a capital gain is included in taxable income. So the passive income generated is inherently lower than the same return earned from a GIC or bond, before you even apply the interest deduction.
Example:
Your corporation earns $100,000 of passive income and the SBD grind begins. But $60,000 of deductible interest brings net passive income down to $40,000 — below the $50,000 threshold. The 12.2% small business rate is preserved.
Beyond the SBD protection, the leverage can also magnify investment gains. If the portfolio grows faster than the cost of borrowing, the corporation comes out ahead on both sides — more investment return and a lower tax rate on business income.
This is not a strategy for everyone. You need sufficient cash flow to service the financing costs. Markets can go down, and leverage magnifies losses as well as gains. The structure is complex and requires professional setup and ongoing monitoring. But for the right incorporated business owner — with the cash flow to support it and a meaningful passive income problem to solve — it can be a powerful tool.
The Insured Retirement Plan: Three Problems. One Solution.
The Insured Retirement Plan, or IRP, is built around a whole life participating insurance policy owned by your corporation. It is the only strategy in this guide that kills three birds with one stone.
The first bird: a tax-sheltered investment environment. Premiums paid into the policy grow completely tax-free inside the policy. No passive income. No SBD grind. The full compounding works on the entire balance, year after year.
The second bird: a retirement income plan. As the cash value builds, you can borrow against the policy through a collateral loan from a bank. Because it is a loan, not income, there is no personal tax triggered. You receive real cash to fund your retirement — or any other need — without a tax bill.
The third bird: building the Capital Dividend Account for a tax-free estate transfer. When you die, the death benefit is paid to the corporation, the outstanding loan is repaid, and the remainder flows into the Capital Dividend Account. The corporation pays that balance to your estate as a capital dividend — completely tax-free. Corporate wealth that would have faced double taxation at death is converted into a tax-free transfer to your family.
No salary, no dividend, no RRSP, no pension plan does all three of those things at once. And because the cash value compounds over time, the earlier you start, the more powerful the strategy becomes. This is not just for business owners in their fifties. The business owners who benefit most are the ones who started early.
The Plan That Pulls It All Together
The most effective retained earnings plans combine multiple strategies, sequenced to match your stage of life and goals. Salary and dividends for current income needs. Family salary splitting where it applies. Leveraged segregated funds to protect the small business rate today. An IRP policy started as early as possible to build long-term retirement income and estate value.
No single strategy is right for everyone. But the business owners who plan early consistently come out dramatically ahead of those who react.
If you want to understand which strategies apply to your situation right now, book a consultation with our team. We work through the numbers specific to your corporation and build a plan that makes sense for where you are today and where you want to be.
Next Steps
We help everyday Canadians navigate the confusing world of taxes—so you can keep more of what you earn. Want to make sure you’re not leaving money on the table? Book a consultation with my team today.
Until next time, happy Canadian Real Estate Investing.
Cherry Chan, CPA, CA
Your Real Estate Accountant
