The main benefit to most high-income professionals using a corporation is tax-deferred investing. In keeping with that, it is common advice to only take out the minimum from your corporation. Just enough to fund your personal spending and investments. That leaves more partially-taxed capital in the corporation to grow. You pay the rest of the tax later when you access it, but the money pile may be bigger. However, there are several situations when it may make sense to pay yourself extra money from your corporation. Even if you don’t need the money right now.
What to Do With Excess Personal Cash
Before considering whether to shift some money out of a corporation, you must consider where it is going to go. This post is about using opportunities to take money out of your corporation efficiently and put it to better use elsewhere. Here are a few ideas.
Planned Upcoming Splurges
Taking extra cash from the corporation that you don’t need this year sometimes makes financial sense. If you are planning a major spend in the next few years, and are not normally in the top tax bracket, then you could spread out the withdrawal over several years.
That income smoothing helps to keep you in lower personal tax brackets. The excess personal cash could be parked in a number of ways until the big spend.
If you do earn interest leading up to spending the cash. Then, tax integration of interest favors personal income versus flowing it through a corporation anyway. So, less tax getting it out and less tax on interest while waiting.
Repaying Personal Debt
If you have excess personal cash, then paying off personal debt like a line of credit is a good use. It is a risk-free tax-free return. It feels good. Plus, it gives your more financial wiggle room to deal with emergencies.
If your mortgage is bothering you, then making a lump sum payment may be a good idea. First, make sure that you are allowed to make additional payments and that it reduces your interest paid. Also, be sure that it is not money you are going to need again soon.
Generally, taking out extra money from a corporation just to repay personal debt is mathematically suboptimal. The interest rate must be very high (like >8%) to make up for the loss of tax-deferred investment growth. However, it is close and the mathematically optimal solution is very sensitive to future market returns, interest rates, and other unpredictable variables. So, I would personally go with what makes me most comfortable. However, if taking money out of the corporation anyway to keep it tax efficient, that is different. If efficiently moving money out, then this is a good use for it.
Tax-Sheltered Investment Accounts
If you have excess personal cash and your debt is at a comfortable level, then catching up on unused tax-sheltered investment accounts is a great use for it. An RRSP or FHSA can mean a fat tax refund while in a high personal tax bracket. A TFSA has tax-free growth and withdrawals. Both have no Canadian tax on investment income while corporate investment income is taxed. So, the growth rate of tax-sheltered investments will outpace investing through a corporation in the long run.
The problem with those registered accounts is the limited contribution room. You have to have paid a salary for the RRSP room, but the contribution is functionally pre-tax due to the deduction. A TFSA requires after-tax personal cash and the contributions are limited. However, if you have room and money to invest – it is a no-brainer.
Spending on something now instead of later.
The preceding usages of excess cash are the most financially optimal. However, money is for spending. Either now or in the future. If your future security is well taken care of, then consider how you could spend the money now.
There are ways to spend money that are more likely to bring you lasting happiness and satisfaction. It takes effort and skill to spend intentionally. If you don’t practice, it is often something that savers often struggle with later.
Otherwise, donating money is an option too. Giving effectively has both mental and financial rewards.
When To Pay Extra Dividends
If your corporation has been making income on its investments, then it has also paid tax on that. Paid upfront and at high tax rates. Fortunately, some of that tax money collected is also tracked by corporate notional accounts. The money in those accounts is released by paying out dividends to shareholders. Like yourself.
Most of the time, you will require enough money to live on that you’ll pay enough dividends to keep your corporation efficient at the same time. However, if you have a large corporate investment income and a low personal cost of living, then it can make sense to pay extra dividends.
Tax-Free Opportunity To Move Money Out
For realized capital gains, your corporation gets half of the gain added to its capital dividend account (CDA) balance. You can use a positive CDA balance to pay yourself a tax-free dividend after filing a special election. You wouldn’t want to harvest capital gains when you don’t need the money personally. However, if you have a CDA balance due to selling an asset, rebalancing your portfolio, or donating appreciated stock, then don’t let it go to waste sitting there.
The main reason to not pay a capital dividend is if all of the corporate cash is tied up in investments that you would not want to hold personally or have a high transaction cost to sell and then re-buy personally. For example, real estate. The other possible reason to delay is if the CDA balance is too small to justify the accountant fees for filing a special election.
Release More Tax Than You Pay
The tax collected on dividend income received by the corporation is tracked in the refundable dividend tax on hand (RDTOH) accounts. For eligible dividends, all of the tax collected (eRDTOH) is refunded to the corporation when you pay enough eligible dividends. The personal taxable income level below which the corp refund is more than the personal tax is shown for each province below.
Only part of the tax is refundable from paying enough ineligible dividends to release nRDTOH due to corporate interest or foreign dividend income. Either way, if the refund to the corporation is more than the personal taxes paid on the dividend. Then, it may or may not make sense to pay out extra dividends.
Paying dividends taxed at a lower personal rate than the corporate refund means less tax in the current year. However, the corporate refund still has to come out, and personal taxes paid at some point. So, it is only tax deferral and there is a future tax liability. If you discount the tax liability in the same future and current tax bracket, the breakpoint over which taking extra eligible dividends is lower. However, it is still a significant income. This is shown in the table below. If future tax rates are higher, then this breakpoint would be lower.
The same thought process is applied to non-eligible dividends in the tables below. Since, the refund for eligible dividends is higher and the personal taxes lower, they would be used before moving to non-eligible dividends.
Other considerations when thinking of using extra dividends.
If the corporation is in a situation where ongoing investment income is going to continue to grow more RDTOH, then paying out extra dividends below the inefficiency points outlined above may help in two other ways. It can move money out of the corporation where investing it won’t generate even more RDTOH. Second, the RDTOH is priced in nominal dollars. So, releasing it also helps to decrease the erosion of its value due to inflation.
If the nRDTOH is due to a one-off massive passive income year, then it is more complicated. Dispensing some extra dividends below the inefficiency threshold can make sense. It becomes a balanced rapidly bumping up personal tax brackets, erosion of the RDTOH by inflation, and how much more tax efficient personal investing is than corporate. A smoother approach of releasing the RDTOH over several years may be better than one massive dividend if inflation is low and the personal tax bump is high.
What you do with the extra money also can tip the scales. Investing it in a tax-sheltered account or via a low-income spouse may favor taking extra dividends. In contrast, investing it in a taxable account at the top personal tax rates may not.
The final point to make that would go against paying extra dividends that are not needed is if it would result in a loss of income-tested benefits. For example, the Canada Child Benefit (CCB) or Old Age Security (OAS). Clawback of those benefits is effectively like a tax increase. When using dividends, that negative effect is magnified because it is the grossed-up value (a 15% increase for non-eligible and 38% for eligible dividends) that is used to determine taxable income. That taxable income is what results in the clawback of benefits.
Release the Buying Power Before It Erodes
The net of the corporate refund minus personal dividend tax means less net tax in the current year below the above personal income levels. Plus, the buying power of the money tracked by those notional accounts erodes with inflation. So, taking advantage of them now is better than later. That is why my algorithm for paying salary vs dividends prioritizes clearing these accounts out before salary.
Salary When You Don’t Need The Money
The complexity of the decision balancing GRIP, dividends, and salary is why I built the CCPC Income Dispenser to automate it. It uses the algorithm shown below. Early on in your career, it is likely that you will have very little investment income in your corporation and require very small dividends to release all of the RDTOH. That means salary to make up the difference.
Those who didn’t get their brains scrambled by trying to decipher the above decision tree may have noticed that there may also be situations when it makes sense to pay some salary from a corporation when you don’t need the personal money. Down at the very bottom. That could be a salary to the owner and/or a low-income spouse.
Most commonly, it would be to a low-income spouse. It is only at very low personal income levels that personal taxes are lower than corporate. The higher-income spouse in a corporation will likely need to take some dividends, bumping their taxable income. Income-splitting using dividends with a spouse is also tougher to meet the criteria for. So, some salary and dividends to the active owner and then salary to a lower-income inactive shareholder spouse would be the most common situation.
However, it could also be efficient to pay out more money than you currently need if you have a very low cost of living or a high corporate tax rate. Corporate active income above the small business threshold is taxed at the higher general corporate tax rate. For either situation, paying some extra salary if the personal marginal tax rate is less than the corporate tax rate. Even if you don’t need the personal cash.
This often confuses people. Actually, I made some mistakes with it in the original version of this post and corrected them after some feedback on Financial Wisdom Forum. There are some really knowledge people on there and I appreciate their quality control. Even after working with this stuff for several years, I still make the occasional rookie mistake.
When Personal Tax is Less Than Corporate
The combined Federal and provincial corporate tax rates are shown in the table below. As you can see, they range from 9% in Manitoba to 17% in Quebec for corporations with access to the small business deduction.
When paying excess salary means less tax than leaving it in a small business.
Those small business rates are lower than the lowest tax marginal tax rate. One of the errors that I made when first thinking about this is neglecting the spousal tax credit. Even if you have a spouse with no personal income, giving them a salary would reduce the spousal tax credit for the higher-income spouse. So, beyond the basic personal amount ($15K), it would be at a ~20% tax rate for each new dollar. It is pretty hard to have a realistic situation where the personal tax rate is lower and you don’t use at least that minimum personal amount to live on.
When Tax on Salary Is Less Than The General Corporate Tax Rate
Just to be clear, the algorithm earlier in the article prioritizes paying enough dividends to release the money in the most valuable corporate notional accounts (CDA & RDTOH) first. Then some salary, or sometimes eligible dividends if there is leftover GRIP, to make up to meet spending needs. This nuance of personal versus corporate tax would only come into play as a consideration if you (or a spouse employed by the corporation) have a low taxable income after doing that.
The general corporate tax rate is higher than some personal marginal tax rates. For Ontario, it is 26.5%. It is as high as 31% in some provinces. For most provinces, the personal tax rate is lower up to incomes of ~$56K. Again, it could make sense to pay that personal tax and move that money out of the corporation at that income level. There are a few exceptions to the $56K estimate based on the province’s corp and personal rates. Alberta actually has a general corporate rate below their lowest personal rate!
Could that really happen?
These situations are not common. However, they are common enough that I have been asked about them. So, I know they exist.
This could be a useful way to income split in a corporation that has income over the SBD limits if both spouses are active enough in the corporation to get moderate market rate salaries. Some dividends could be used to clear out the RDTOH and then equal salaries to make the taxable incomes $54K for each partner. That may be more money than a low-spending couple needs. However, it is more tax-efficient than leaving money in the corporation. Both in terms of lower current-year taxes and growing a smaller tax liability in the corporation for later.
It could also be useful for a business owner without access to the small business deduction and a low cost of living. For example, Quebec has extra hoops to jump through for the SBD and other professionals may have to share their SBD with other partners in a group practice. If they only need $60-70K to live on, they may still want to take money out of the corporation as long as their personal tax rate is less than the general corporate rate.
Another time where this could come into play is if there is high corporate investment income, but no dividend splitting with a spouse. The spouse may work for the corporation, but not pass the 20h/wk test. In that case, it is possible that the dividends that the high-income spouse needs to take to clear the corporate notional accounts are enough to cover their cost of living. However, paying the low-income spouse a salary may still be a lower tax rate than the corporate rate. They could then invest their income to earn more investment income at their low personal rate moving forward. Without running afoul of the attribution rules.
Summary
Rules of thumb are attractive because they are simple and easy. However, optimally using a corporation is complex. You are hopefully using a good accountant to help you. Even then, you must know some of what is happening to make sure that you get your money’s worth. The best plan for you rather than the rules of thumb.
For compensating yourself, paying enough dividends to release refundable taxes, then salary to make up a personal cash shortfall is a good rule of thumb. So, is taking advantage of corporate tax deferral by not taking out extra. However, this post describes times when you may want to take out some extra money from your corporation. Plus, ideas of how to better deploy it. Hopefully, if these situations apply to you, then you can bring them up with your accountant. Even this post is general in nature and there are nuances. If you don’t know, then it is a sign that you should find out.
Mark, another very helpful article into the weeds of Corp tax efficiency.
I’ve accumulated a moderate amount of Corporate bloat due to not understanding these things until reading your articles, and an accountant who is not on the ball about this. So this year, especially as being the first year I’m too old to contribute to an RRSP, I decided to go all dividends in order to pass some of this gas.
A financial planner suggested I should have continued with salary only, because I plan to retire in a year or so, and it’s more efficient to release the RDTOH via dividends in retirement when I no longer can draw a salary anyway, and given the short time until retirement the effect of inflation on the nominal RDTOH is therefore minimal.
I see their point, but am not sure. Is this an exception to the rule about releasing RDTOH when it becomes available – a short time frame to retirement and RDTOH release being much more tax efficient than non RDTOH dividends and no ability to pay a salary?
Hey Grant,
Thanks! I have to be honest and say that I was sub-optimally paying myself until the last couple of years when I really figured this stuff out.
I think that you did the right thing. I don’t think that you should have continued with salary if you have large notional account balances. Releasing RDTOH as soon as you have it is more efficient. The reason is that it is priced in nominal dollars and erodes with inflation in terms of the buying power it represents. So, better to use it and have to draw less for the same buying power than later when it is not worth as much in “real” dollars. Won’t matter much for a year or two. However, when Ben Felix and Braden Warwick modelled optimal compensation, they found that a moderate income corp low spender ended up dividend only in mid-career. So, many years of dividends only while working to keep the investment income taxes flowing. That was more efficient than salary due to the RDTOH accumulation and erosion. Same with the simulations I ran to test my algorithm. That held up, even though less RRSP room. Salary is only more efficient when you aren’t forgoing a RDTOH refund.
The one possible exception could be a corporation with no access to the SBD and no RDTOH to release. In that case, paying salary as long as possible is probably more efficient. That is what my modelling showed and I know Ben and Braden are having a look at that nuance with their more advanced model.
-LD
Thanks, that makes sense. Perhaps the way to think about it is that although you pay slightly more tax with dividends than salary on the personal side, you lose much more on the Corporate side by not releasing RDTOH, which will then get eaten alive by inflation and not invested in the Corp with an expected return of 7%. Then, in retirement when you can no longer draw a salary, apart from CDA, you’ll be taking out dividends. You’ll have only one year’s worth of eligible dividends, so will pay a bit more tax on the personal side, (as you’ll have less eligible dividends) but this is more than made up for by years of compounding of the earlier released eRDTOH in the Corp. Then, of course, the rest of the dividends you’ll take out will be non eligible dividends.
I must admit it’s a bit counterintuitive to me that it’s better to take out dividends at the expense of creating RRSP room, given the benefits of the RRSP. I guess that’s another example of how we are not hard wired to easily understand the power of compounding, especially over long periods of time.
Yes. That is exactly it. It is definitely counter intuitive. It wasn’t until Ben’s paper and running my own simulations that I believed it. Compounding is hard and inflation is hard – together I can’t do it without a simulator.
-LD
Great article. This year I’ve projected above $50K in passive income from my corporate brokerage account which are dividends from stocks for the first time.
This doesn’t include capital gains from also selling some stocks.
With inflation at over 10% and companies raising dividends it didn’t take long for my $2.5M portfolio to get over limit .
I wonder if the $50K limit will be raised? Likely not as CRA wants to trap more small businesses in their net.
I read your article. Just wondering the best way to take cash out of corp ? Or is their no best way?
Any cash or stocks taken out of corp would be considered salary or dividends?
I’ll have to read article again and talk to my accountant.
Thanks
Hey Dad MD,
The passive income limits explicitly were not tied to inflation like the personal tax brackets. It would take a deliberate legislative act to increase it. I am not holding my breath. If in Ontario or New Brunswick, going over the passive income limit can be a good thing. It is complicated, but those provinces broke tax integration in our favor.
There are multiple ways to decompress a bloated corporation. I mentioned some in the current article and wrote another article about it here. Another strategy, if you already pay an advisor, is to use an Independent Pension Plan to shift more money out of the corp and into a pension.
If you took stocks or cash out of the corporation, it would be considered taxable income. In the case of stocks, they would be deemed to have been sold and the corporation taxed on the gain. The taxable half would likely be considered an ineligible dividend, but I am not sure. Seems cleaner to just do a capital gains harvest, pay out a capital dividend, and then re-buy the stock personally. An accountant would be the best person to advise on that.
The final option is to pay more salary and spend more money or to work less. Both are ways to lower your active business income 🙂
-LD
Thanks Mark for the detailed response
Thank you for your great article. I’ve been searching for this exact breakdown all over the forums and blogs: “The interest rate must be very high (like >8%) to make up for the loss of tax-deferred investment growth. ”
I have a personal LOC debt that I’m eager to pay off in this rate environment, and prime rate is currently 7%. The debt is for an income-generating rental (good debt) but the interest rate is erasing my generated income.
Suppose I take out $155,000 salary every year to pay for my life, and max out my RRSP/TFSA each year, and the corp has $1.5M in investments, and I invest $150,000 each year in the corp. I would instead, invest less in the corp for a few years and take $50,000 dividend each year to service the debt.
Compounding that prime rate, I am calculating the difference between the corporate small business rate and the marginal rate breaks even around 3.5-4 years.
The uncertainty here is that prime rate may go down significantly rather than go up.
Do I have all the facts to make my decision, or am I missing something important?
Thanks!
Hey Northern Doc,
The mathematically optimal strategy is sensitive to a whole bunch of inputs and it comes out pretty close. So, I would make my decision based on what made me feel better. The psychological burden of debt. Sounds like it is bothering you enough that you want to whittle it down. I don’t think you can go wrong with that. In terms of how to pay yourself, taking a bit extra would be needed to do that. I would take just enough dividends to release the RDTOH from my corporate investment income and then the rest as salary. The salary for max RRSP is now up around $171K. So, you could increase that get more RRSP room and tax refund on contributions. Plus, salary is a little more tax efficient (if no RDTOH to release).
-LD