With the end of the year approaching, business owners must make important decisions quickly to reduce their business taxes for the year, one of which is paying out bonuses. Read further to figure out what decision is best for you.
Bonuses vs. Dividends
Business profit earned by a Canadian controlled private corporation that is $500,000 or less is taxed at a lower rate of 15.5% in the province of Ontario. However, business profits in excess of $500,000 are taxed at a higher rate of 26.5%.
In order to avoid this higher tax rate, consider declaring a bonus to reduce your corporation’s profits to not more than $500,000. So long as the bonus is declared by the end of your corporation’s fiscal year, it will count as a tax deduction, even if it’s not paid. When you receive the bonus, you will pay personal tax on it at your marginal tax rate, which in Ontario is 53.5% as of 2016.
At a first glance, paying a bonus in order to avoid high corporate taxes of 26.5% seems foolish, given that the personal tax on bonuses is 53.5%, even more.
So why not keep profits inside your corporation, and then pay them out as dividend to you in the future when you personally need the money? In this case, your corporation will pay 26.5% of its profits in taxes, and when you take out a dividend at some point in the future, you will pay personal taxes at a rate of 38% on the dividend you received. This comes to a total of 54.4% in taxes, when the corporate and pesonal tax paid are added together. That’s 1% higher than paying a bonus.
Now you’re probably thinking that you’re better-off paying a bonus to yourself instead of a dividend, because the total tax bill is lower with a bonus. Well, you’re right, but for the fact that your company could potentially earn even more profits by reinvesting its money rather than paying a bonus to you. For example, if your corporation could earn a 15% rate of return on its investments, it would make more sense for your corporation to keep its profits in excess of $500,000, rather than paying a bonus to you.
So Here’s the Tip:
Choosing between paying a bonus or a dividend from business profits in excess of $500,000 depends on your corporation’s ability to earn a decent rate of return on its investments. If the rate of return is negligible, pay a bonus to yourself. If the rate of return is high, your corporation should reinvest its profits and pay a divided to you in the distant future.
The information provided on this page is intended to provide general information. The information does not take into account your personal situation and is not intended to be used without consultation from accounting and financial professionals. Allan Madan and Madan Chartered Accountant will not be held liable for any problems that arise from the usage of the information provided on this page.