Changes to the dividend tax credit system will increase taxes on the majority of dividends paid by small businesses. The changes are effective as of January 1, 2014, thus most corporate business owners will feel the tax increase for the first time on their 2014 personal tax return. This budget change will affect how corporations should approach their tax planning for 2014.
In order to develop an understanding on the dividend system, you need to understand that there are two main types of dividends: eligible and ineligible. Eligible dividends are generally paid by public companies, and can also be paid by private companies with active business income over $500,000. It is important to note that the taxation of eligible dividends has not changed. Ineligible dividends are generally paid by small businesses. It is the treatment of ineligible dividends that has changed.
The changes to the taxation of ineligible dividends can be summarized as follows:
- The dividend tax credit was revised from approximately 2/3 of the gross-up amount to 13/18 of the gross-up amount. This resulted in a reduction of the federal dividend tax credit rate from 13 1/3% of the grossed-up dividend to 11.017%, and from 16 2/3% of the actual dividend to 13% of the actual dividend.
- The gross-up on ineligible dividends will decrease from 25% to 18%.
- For taxpayers with no income, the amount of dividends that can be received tax-free has been reduced from $43,432 in 2013 to $35,551 in 2014. Students are eligible to receive more since they have tuition and education tax credits available to them.
Evidently, the calculation of tax on dividends is quite complicated. Although the benefit of paying dividends is less in 2014 than in previous years, it is still considered more beneficial for active businesses to pay out dividends rather than salary. However, other factors such as RRSP limits, CPP costs/benefits and Employer Health Tax costs must also be considered when reviewing the salary/dividend mix. We recommend that you review the salary/dividend analysis with a tax expert. Contact us to simplify the process for you, save you time and money while you focus on operating your business.