My Wealth Journey Part 4: Tax Planning

In the preceding installment of my wealth journey, I was awakened from my reverie by a series of tax increases. That, coupled with government rhetoric about how I wasn’t doing my fair share, got my attention. It caused me to pause, reflect, and recalibrate. I recognized that working more translated into very little after-tax money for us to spend. In response, we restructured our spending. Exiting the earning and spending trap was instrumental in redirecting the fruits of our labor to more directly support our priorities. Spending less meant less consumption tax and a lower income requirement. Less income also meant lower income taxes. But, that isn’t the whole story.

Being told we had unfair tax advantages caused me to examine our tax planning much more closely. Today, I will share what I learned that helped us plan more effectively. I’ll start with something we did well (but that is commonly overlooked) and describe areas where we made major improvements. Consider what may apply to your situation.

Impact of Tax Planning

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Tax Reduction

To engage your interest, I will show the overall impact of tax planning in our situation. There is real money at stake. Before 2015, I paid little to no attention to tax planning. We made sure to max out our RRSP room each year, but that was it. Our salary and dividend mix was random and reactive. We didn’t plan for near-term big-spend items nor build flexibility for a tax-efficient drawdown strategy in the future. Basically, we floated along while our accountant did his best to file what we handed to him at tax time.

As you can see in the chart below, we started paying attention around 2016. There were many low-hanging fruit that I was simply unaware of or had neglected to pay attention to. Some of those strategies are available to all Canadians, but I also didn’t understand how to use my corporation effectively. Those who have followed my blog since its 2017 birth will have shared in my journey of enlightenment as I learned more about tax planning and using a corporation. As you can see, the impact on our tax bills (red line) was substantial.

While we were not paying attention, we spent about twice as much per year on taxes as on lifestyle expenses. As we started to pay attention and I learned more, the spending dropped to roughly the same on income taxes as on lifestyle expenses. Those high tax bills early on were the cost of not planning or understanding how to use my corporation optimally.

You’ll also notice that when the income line dropped precipitously, my taxes did not. That is because my corporation functions like a dam to take fluctuations in income and smoothly release the money as needed to fund my lifestyle. We are now releasing the money more efficiently, but with a lower income, I am adding to the “corporate reservoir” more slowly.

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Redirecting Time & Money

After 2021, by reducing our tax burden, we were also able to redirect our time and money more directly to causes we care about. I dramatically changed how I spend my time—earning less but impacting my family and community in other ways (the green line dropping). We also donated more deliberately and effectively to charities (the purple line rising).

I was recently asked about what moved the needle the most for us on the Beyond MD Podcast. Understanding more about tax planning made a big difference. I can’t assign a percentage contribution to different aspects, but I will highlight where we made major improvements. They are in areas that I frequently see colleagues neglecting, too.

Use Tax Sheltered Accounts!

This seems obvious and is something that we did well from the beginning. However, I constantly encounter colleagues who have unused RRSP contribution room or unused TFSA space. That may be due to a lack of saving or investing in general. However, it is also commonly a result of advice to “keep everything in the corporation”. I’ll describe why I think that is bad advice and also mention a couple of other commonly missed opportunities.

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RRSP Catch-Up

If you already have unused RRSP room, shifting money from a corporation into an RRSP costs nothing. You can pay out a salary bonus – there is no corporate tax because it is a deductible business expense. If you have unused RDTOH (more on that later), a dividend to catch up on your RRSP contributions may even mean a tax refund! On the personal side, there is no tax on the contribution. It is deductible against personal income. The net effect is shifting money into an RRSP from a corporation tax-free. That is 100% tax deferral, compared to the partial tax deferral of leaving it in the corporation. Further, interest or dividends from corporate investments are taxed annually. In contrast, there is no annual tax drag on growth in an RRSP.

Empirically, it makes sense that RRSP contribution room should be used rather than “keeping it all in the corp”. There are also papers to demonstrate that. More than one. Despite that, I see incorporated business owners with unused RRSP contribution room. We expand on a few times when a delay could make sense and debunk some of the other arguments against RRSPs on The Money Scope Podcast.

Avoiding the use of salary to keep more in the corporation (and lose out on RRSP room generation) is also usually not an optimal compensation strategy. Salary is favored by tax integration. There is payment into CPP as a side effect, but CPP is usually a good deal for business owners. Certainly, it is not a cause to pass up on the other benefits of salary. Shifting money from the corporation into an RRSP or IPP diversifies against tax risk, is tax-sheltered, and delays corporate bloat.

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TFSA Wastage

Unused TFSA contribution room is another commonly missed opportunity. A TFSA is contributed to with after-tax income, but it then grows tax-free and comes out tax-free. For someone who is not incorporated, this is a no-brainer. If in a high-tax bracket or collecting the Canada Child Benefit, you might prioritize an RRSP to get a fat refund. However, once that is full, investing using a TFSA is vital.

The tax-sheltered room in a TFSA grows with it. So, don’t waste that opportunity by using a HISA TFSA unless you need the money soon. Rather, open a self-directed TFSA at a discount brokerage and invest for long-term growth. Also, don’t delay longer than you have to. Time is the most powerful variable for compound growth.

Some incorporated professionals avoid using their TFSA because they are reluctant to take money from their corporation and pay more personal tax. On a one-year basis, that makes sense. However, in the long run, the tax-free growth in a TFSA should overtake and outpace money left invested in a corporation. A possible exception would be a deferred capital gains-only corporate investing strategy. That would require major trade-offs. Depending on the investment mix, a TFSA could take about 10 years to pull ahead of a diversified portfolio in a corporation, and the rest is gravy. The investment timeframe for most incorporated business owners is their lifetime. Hopefully, that is much more than a decade.

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Lay the Groundwork for Future Income Splitting

One aspect to consider when contributing to registered accounts is your exit plan. A spousal RRSP can allow you to income-split with a lower-income spouse if you retire early. If you retire after age 65, you can pension-split with an RRIF or dividend-split from a corporation. We started building a spousal RRSP to give ourselves that flexibility because my retirement age is uncertain.

Income-Splitting

Canada’s tax system is progressive and also taxes income on an individual basis rather than as a household. That means two households can have radically different after-tax buying power depending on how evenly the two partners earn income.

Shifting income to even it out and lower the household tax bill is called income-splitting. I already mentioned how RRSPs lay the foundation for that in the future, but there are also ways to income split now.

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Paying a Spouse Salary

Having your partner involved in your business has benefits beyond income-splitting. For us, it also improved the efficiency of running my practice and billing effectively. Prior to 2015, my wife helped by doing my billing and with some basic admin for the corporation. I also had an admin assistant who was employed through the academic side of my practice. With the government’s stated intention to hobble dividend splitting for incorporated professionals, I restructured.

I had only been paying my wife ~18K/yr. That was roughly what I would have been paying for a third party to do my billing and bookkeeping when I started. However, I had not increased that since 2006 despite almost a decade of inflation. You can pay a spouse a market-rate salary for work done. So, I phased out my expensive admin assistant and shifted that work to my spouse. At that point, I was also a Department Chief. So, I was eventually able to pay her a salary of $60K/yr, which was commensurate with the going rate of a comparable position, accounting for salary in lieu of benefits.

That meant $60K/yr less paid to third parties and kept within our household instead each year. Plus, it would be taxed at my wife’s lower tax rate. Honestly, my frustrations also dropped and the quality of work done rose substantially. I was lucky not only to have work that my spouse was willing and able to do for our practice but also that she is excellent at organizing and dealing with doctor quirks.

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Dividend Splitting

Fortuitously, when the government did pass its Tax On Split Income (TOSI) rules, my wife was also working enough hours that I could continue to pay her dividends. There are scant ways around TOSI for those with a service-based corporation. However, a spouse who actively contributes more than 20h/wk while the business is operating allows an exemption. The exemption is for dividends paid in the same calendar year, or in perpetuity after a total of five years of meeting the criterion. We’ve kept timesheets and payroll evidence of that work for more than five years now. It is vital, if using this exemption to enable dividend-splitting, to not exaggerate the work done and to document it carefully. Dividends off-side of the TOSI rules are taxed at the highest marginal rate.

The advantage of dividends for income-splitting is that they do not need to be at the market rate (unlike salary). I could not legitimately pay her a salary of $100K, but I could give her a $100K dividend if I wanted to. Prior to 2015, we had not been paying close attention to this. Subsequently, we started making sure that our taxable incomes were roughly the same each year. After our base salaries, we could add dividends to even our taxable income and meet our spending requirement. That kept us in the lower tax brackets as a couple.

Over the last couple of years, I’ve refined income-splitting within my optimal compensation algorithm. I’ve also built that into my salary & dividend optimizer calculator to help people get a sense of their own situation (to then discuss with an accountant). Prior to this, we were random in our compensation mix, and our accountant would deal with what I handed him. However, now we have a good conversation and plan – not only for better income splitting but also to plan income smoothing for major purchases. The complex algorithm is shown below, but I will give some simplified tips in the next section.

Tips to Keep a Corporation Tax Efficient

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Divert Passive Income Growth

Using registered accounts and income-splitting with salary and dividends have helped to keep our corporation tax efficient. As mentioned, redirecting money to RRSPs and TFSAs has helped that money grow tax-sheltered and left less money invested via the corporation. That translates into less passive income within the corporation.

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Dividends to Keep RDTOH Flowing

When a corporation collects interest or dividends, it is taxed at a high rate upfront—approximately the highest personal rate. The corporation then gets all or some of that refunded (RDTOH) when it pays dividends to shareholders. The shareholder pays tax on those dividends. When you consider personal and corporate tax, releasing RDTOH with a dividend is more efficient than using salary.

Since we require money to live on, paying dividends to get our corporation’s RDTOH refunded has kept it efficient. The net corporate tax with RDTOH flowing is 0% for eligible dividends, ~20% for interest, and ~31% for foreign dividends. That is close to the lowest personal marginal tax rates, which translates into a tax deferral advantage for the corporation.

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How Much Dividend to Release RDTOH?

While I’ve already mentioned my compensation calculator, a quick rule of thumb is to estimate your corporation’s passive income and pay roughly that amount out as dividends each year. Strictly speaking, that results in slightly higher dividends paid out than needed. Eligible dividends require an equal dividend paid out. Interest requires about 80% paid out, and foreign dividends about 50%. However, it is simple and close enough. We make sure to pay enough dividends before the end of our corporation’s fiscal year. Our accountant reconciles the proportion that were eligible versus non-eligible dividends when they do our T5 slips each January.

For example, with the income mix below, $23K of dividends would release the RDTOH. However, a quick guess would also release the RDTOH while using an extra $7K of dividends. The tax integration inefficiency from the extra dividends compared to using salary is about $35 for Ontario at the top marginal rates in this example. A small cost for saving some brain cells.

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Salary to Make Up the Difference

Unless your corporation has a massive passive income and you spend very little, you’ll require more than the dividends required to release RDTOH to live on. Make up the rest of the difference using salary. You can fine-tune the amount of salary and dividends attributed to each spouse. Plan enough extra to also fill up your registered accounts.

Put together, most people will have a mix of salary and dividends. Early in a career, when there is little invested through the corporation, optimal compensation will be all or mostly salary. The proportion of dividends will increase as you invest via your corporation and its passive income grows. The salary required will also gradually shrink over time as those dividends fund more of your lifestyle.

Despite optimizing and using registered accounts, the dividends required to release the RDTOH may become greater than what you need to live on. At that point, you will want to consider whether to spend more (you are obviously doing well at saving already) or perhaps invest personally. Building some personal investments to draw on can also help with funding splurges.

Tax-Efficient Splurge Funding

Between 2012 and 2024, we splurged on something big every few years. Our major splurges are shown below. We built a barn, which naturally required a motorhome to fill the vacuum inside. That was upgraded to a 45-foot rockstar bus a couple of years later. We decided to move in 2019/2020 and carried two houses during the overlap. Our “new” house required major renovations. As we are transitioning towards the freedom of having our kids finish high school, we recently bought a cottage nearby to spend time in. Those were all big purchases. Early on, our splurges came with massive tax bills. With better planning, our taxes remained low with the latter splurges.

I previously wrote about strategies to move big money out of corporations. Awareness of options and sharing your spending plans with your accountant in advance can reduce your tax bill through better tax planning. We most recently used a combination of strategies to fund our cottage purchase, and I will use that as an example. We used a combination of personal investments, capital dividends, and a shareholder loan.

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Personal Investments

I mentioned earlier that we had slowly built up some personal non-registered investments over time. Some came from downsizing from our massive house. We had also intermittently strategically moved money out of our corporation efficiently using capital dividends and invested the excess. This gave us a pot of money to tap with minimal tax consequences.

While some of our investments have massive capital gains due to years of compound growth, we did have others with a small tax liability. We use multiple ETFs to enable that flexibility, but even if we used all-in-one ETFs, we could easily build multiple options over time. We sold ETFs with the smallest capital gains while keeping close to our overall target asset allocation. So, most of the money freed up was just the return of capital (no tax). Plus, only half of the capital gains were added to our taxable income.

We did not touch our TFSAs. The tax-free growth of that tax shelter is simply too valuable for us to miss time invested in it. Plus, we would have to draw more income from our corporation to refill it anyway.

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Capital Dividends

We were able to pay ourselves a juicy tax-free capital dividend to add to our cottage money. To do this, you must have a positive capital dividend account (CDA) balance. We generated that in two ways.

First, we did a capital gains harvest. We had actually done that just prior to June 25th to beat the proposed increase in the capital gains rate (that is now hopefully dead). Basically, we sold corporate investments that had capital gains and immediately rebought them. So, we did not miss time in the market, but triggered a capital gain inside our corporation. Half that capital gain was credited to our CDA. We will also likely repeat this maneuver next year to repay part of the shareholder loan we used.

Second, we donate some of our ETF/stocks with the highest capital gain from our corporation “in kind” to registered charities each year. Giving regularly is an important part of our financial plan and happiness. Doing that by donating appreciated securities from our corporation is a tax planning ninja move. In addition to removing the tax liability of the capital gain, it is deductible against corporate income. Plus, the full capital gain (not just half) is credited to the CDA – enabling a larger tax-free capital dividend.

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Shareholder Loan

Even with the money from our personal investments and capital dividend, we still had a shortfall. To meet that, we would need to draw money as taxable income from our corporation. Because we planned to close on the cottage in early 2025, we drew some extra income at the end of 2024. We then accessed the rest of the money as a shareholder load. We will repay part of that in 2025 by paying ourselves an extra dividend in late 2025 (and hopefully use a capital gains harvest if markets are up). The remainder will be repaid by drawing an extra dividend in early 2026 to clear the shareholder loan before the end of our fiscal year.

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The Net Effect: Income Smoothing

The net effect is to spread the extra taxable income out over three tax years instead of one. This will keep us in lower tax brackets each year compared to if we had just taken out a massive lump sum in 2025 to buy the cottage. We should manage to keep our incomes equal and stable within a few thousand dollars each year. If we had just taken a massive taxable dividend in 2025, we would have paid about $75K more income tax.

Tax Planning Lessons

In sharing the evolution of my tax planning story, I hope to impart a few key lessons.

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For Everyone

Paying attention to tax planning to reduce the amount of tax you pay each year makes a difference. We cut our tax bill substantially through better tax planning strategies.

Use your tax-sheltered accounts. That applies whether you have a pension that just leaves you with TFSA room or if you have a corporation. An RRSP and TFSA are tax-deferred and tax-free, respectively. A corporation offers only partial tax deferral, and investment income is exposed to annual tax.

If you give to charity, consider doing so by donating appreciated securities. This is especially powerful when using a corporation.

If you have a radically different income from your spouse, consider income-splitting strategies. There are several strategies available to all Canadians, whether incorporated or not. Having a spouse work for the business presents additional opportunities.

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Corporate Tax Planning

Corporate tax planning should be done in collaboration with your accountant. However, to get the most out of it, you must understand some basics of how a corporation works. That made a big difference for me and is why I have spent so much time sharing that incorporation curriculum here and on The Money Scope Podcast.

The power of a corporation lies in smoothing income. That could be in the short term to fund a splurge or smooth out high- and low-income years. This requires you to discuss your plans with your accountant in advance, which gives you more options. A corporation also helps you smooth income over your lifetime. Partially taxing some as business income during your high-earning years and paying the rest when you take dividends later. That also requires planning to smoothly release money from your corporation over your lifetime – it all has to come out eventually. This is where a financial planner may help.

Keep your corporation tax efficient by using a mix of salary and dividends. That will be mostly salary to start, but that may shrink as you require some dividends to keep your RDTOH refund flowing back to your corporation. Some accountants may not pay attention to this unless asked. Further, they may not be aware of your investing strategy – that drives passive income. Be an educated client, and point them here or to some of the articles I linked to if required.