This article in the globe and mail discusses a novel tax strategy. If you are an incorporated business professional - a lawyer, accountant or consultant - it might be more benefical from a tax perspective to retain excess funds that would normally be transferred to an RRSP, in the corporation. The business owner would withdraw funds in the form dividends instead of a salary. (It is necessary to have earned income eg. a salary to build RRSP contribution room. Dividends are not considered to be earned income.) This strategy results in the following tax savings:
- Corporate profits (depending on the province) are taxed at rates between 12% and 19%
- Dividends are generally taxed at a lower rate than salaries.
- The shareholder is not required to pay CPP contributions on dividends, which can result in a savings of up to $10,000,
Before taking the plunge, however, it is important to consider the following:
- This strategy is most beneficial when the corporate pretax profits are under $500,000. Profits in excess of this amount are taxed at a significantly higher rate.
- The corporate structure is more complicated and should ideally incorporate a holding company and a trust for maximum protection. Holding funds in the operating company make them available to creditors and potential lawsuits, which defeats the purpose of incorporating.
- Whereas restrictions surrounding RRSPs make it difficult and cumbersome to withdraw amounts from retirement accounts, using this strategy requires a great deal of discipline.
According to John Nicola of Nicola Wealth Management this structure works for professionals, whose major asset is their own labour and intellectual effort, it’s probably not wise for a manufacturing company or more-tangible business that could be sold for a substantial career-ending payoff. “It’s more incumbent on a professional to build wealth,”
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