It’s that time of the year again.
It’s rainy and it’s getting cold.
For accountants, it’s the less busy time of the year.
Many of us use this less hectic time at various professional development courses to update ourselves.
It is usually during these courses that we are told that corporations do not help us save taxes, especially if you hold investments such as real estate and others!
This is because in Canada, there is something called Tax Integration! The objective of our income tax system is to tax you the same amount regardless of the form of ownership.
The calculation done today is based on current year, current income.
If you earn $100K in your corporation and declare it as dividend to yourself in the same year, you will be taxed, more or less, the same amount as if you earn this $100K directly in your personal name. That is roughly $26K of income tax payable if you earn the $100K directly in your own personal name.
The beauty of having a corporation means that you have a choice to leave the income into the corporation until you need it personally.
Say you really only need $40K for your personal expenses in the current year, you pay $5,823 tax in Ontario. The corporation pays 15.5% tax on the remaining $60K, corporation pays $9,300 in the current year.
Next year, you may need the remaining $51,700 (profit after paying tax at the corporation level). You can then declare a dividend to yourself for $51,700. You then pay $3,133 of tax in year 2.
A combined income tax payable of $18,256, compared to $26K if you were to earn it in the same year. $8K tax savings. Who wouldn’t want that?!?
You’re essentially using a corporation to split income with yourself, in multiple years.
Say you have a lower income spouse, an adult child or parents who are in a lower bracket, you can even split income by making them a shareholder to further lower the liability.
A few months ago, I met with a couple to map out their tax planning strategies. The husband owns a small business in the form of a corporation and the wife is a professional that earns a 6-figure salary.
They want to maximize their after tax dollars and they want to invest in real estate.
On top of the income splitting flexibility mentioned above, this couple can even use higher after tax dollars to invest in real estate because active business income is taxed at 15.5% .
When you make a decision on whether you want to incorporate or not, make sure you speak to us, professional accountants, to understand the long term potential and flexibility associated with the corporation first.
Until next time, happy Canadian real estate investing!
Cherry Chan, CPA, CA
Your real estate accountant
Jill
Hi Cherry, thanks for the post. Not being familiar with corporation taxation… I have a question based on your above scenario: in Year 2, when you gave the example of carrying over $51,700 and paying it to yourself as a dividend, how does that work if you need to draw on 50K for personal expenses that same year? Is it cumulative? Are they taxed separately? Can you please explain. Thanks in advance.
Cherry Chan, the Real Estate Accountant
There are a few options to draw money out from your own corporation. You can do so by repaying yourself first (majority of the times you loan the money to your corporation to purchase properties). Repayment of shareholder loan is tax free. Once you draw down all your shareholder loan, then we consider taking out dividend or salary, depending on your tax situation. Not sure if I answer your question, feel free to comment and email me if you want more information.