Episode 174: The Costly Mistake Canadian Business Owners Make With Dividends and Payroll

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Are you a Canadian business owner earning more than $500K in your corporation — and unknowingly setting yourself up for a surprise tax bill?

Many incorporated Canadian entrepreneurs get caught off guard when they grow too fast and cross key income thresholds. That growth feels great—until the CRA takes a bigger slice than expected. If you’ve ever been hit with an unexpected tax bill, or you’re unsure if your salary-dividend mix is working for you, this episode is a must-listen.

In this episode, you’ll discover:

1. Why crossing the $500,000 net operating income mark can double your corporate tax rate — and what to do about it.

2. The smart way to structure your salary vs. dividends to keep more money in your pocket, not locked in your corporation.

3. How to front-run tax surprises with timely planning, and use RRSPs and payroll adjustments to your advantage.

Press play to learn how to turn a “good problem” — making more money — into a long-term wealth strategy, not a tax trap.

Resources:

• Ready to take a deep dive and learn how to generate personal tax free cash flow from your corporation? Enroll in our FREE masterclass here. 
• Book a Discovery Call with Kyle to review your corporate (or personal) wealth strategy to help you overcome your current struggle and take the next step in your Canadian Wealth Building Journey!
• Discover which phase of wealth creation you are in. Take our quick assessment and you’ll receive a custom wealth-building pathway that matches your phase and learn our CRA compliant tax optimized strategies. Take that assessment here.
• Dig into our Ultimate Investment Book List
• Follow/Connect with us on social media for daily posts and conversations about business, finance, and investment on LinkedIn, Instagram, Facebook [Kyle’s Profile, Our Business Page], TikTok and TwitterX. 
  

Calling All Canadian Incorporated Business Owners & Investors:

Consider reaching out to Kyle if you’ve been…

• …taking a salary with a goal of stuffing RRSPs;
• …investing inside your corporation without a passive income tax minimization strategy;
• …letting a large sum of liquid assets sit in low interest earning savings accounts;
• …investing corporate dollars into GICs, dividend stocks/funds, or other investments attracting cordporate passive income taxes at greater than 50%; or,
• …wondering whether your current corporate wealth management strategy is optimal for your specific situation.

Navigating the complexities of the Canadian tax system is critical for business owners who want to build long-term wealth and achieve financial independence in Canada. From managing surprise tax bills to balancing salary vs dividends, corporate wealth planning demands strategic financial optimization. A well-structured Canadian wealth plan blends personal finance with corporate tax efficiency, enabling smart investment bucket strategies, RRSP optimization, and capital gains planning. Whether you’re aiming for early retirement, growing passive income, or legacy planning, aligning your financial systems with clear vision setting and using tailored tax strategies can make all the difference. Embracing a modest lifestyle wealth approach, leveraging real estate investing in Canada, and understanding corporate structure optimization are key to unlocking financial freedom in Canada—especially for the driven Canadian entrepreneur.

Transcript:

Kyle Pearce: All right, Canadian wealth secret seekers, I just hopped off a call with clients who I’ve been working with to help them through their corporate and personal wealth management system and plan. And you know, something that came up, which was unexpected, both for me and for them was a surprise tax bill. What is that surprise tax bill, you will find out in today’s episode of the podcast.

Jon Orr: Hmm. Tell me more. Let’s dive right into this kind of surprise tax bill because I think I can sympathize with these clients that you just got off the phone with because I think we’ve all probably been there where, and this is the good problem to have, is you get all of a sudden hit with a tax bill that you’re like, oh, I didn’t account for that in my installments or I didn’t account for that.

in my planning. And it’s because it’s like, when the good is good, it’s all of a sudden, it’s like, yes, we’re rolling ahead. We’re making you’re making gains, we’ve made too much money, which is the good problem to have. made I made extra money than I did last year. And all of a sudden, my tax bill is a little higher. Or maybe it’s a lot higher. And now we have to kind of go, what do we do? And then then go like, what do we what does that mean? Like, where are the where are the gaps? Where the

We’re the pieces that I can start plucking at to actually like make it a little bit more tax efficient rolling into next year. Because honestly this year it’s, it’s done this year. We’re paying this tax bill. but now it’s like, well, what do we do to fix that or, make optimizations for next year so that, we, we take, we pay less tax, and we don’t have this problem again.

Kyle Pearce: Mm hmm. Well, and I think one of the other pieces too is is the more you know and educate yourself on the rules that we are playing in, right? So we’re playing a game each and every day here 365 days a year. And it’s like, and if you don’t know the rules, if you’re not really sure what’s happening and what the impact of earning more income earning less income or doing different moves with your assets, if we’re not sure what those rules are, then you will get hit with the surprise.

sort of bill. So John, you and I actually had just last week a planning call just you and I, where we were actually trying to front run this bill that we were anticipating, which is going to be higher due to our associated operating companies having generated more income than we did last year. And when that happens, that good problem happens, right, john, you earn more money, which means you show more profit, which unfortunately means

you pay more taxes. But there’s a specific place and time for Canadian incorporated business owners where the hurt can hurt a whole lot more than you might suspect. And this is when your net operating income creeps up over the $500,000 per year mark. And that is exactly what has happened to this couple. They for many years have had

good income inside their operating company. They’ve been paying themselves out as T4 employees. So they, you know, they they’ve been feeling good about that. They’ve been paying a certain amount in taxes and up until this last year, this was the 2024 tax year. They kept their net operating income unknowingly under $500,000. Like there was no strategy to do this. It’s just how it worked. And because of that, there was of course some years where they earned a little less.

And some years where they earned a little more. the difference was is that that difference was at the same tax rate. Now they are not from Ontario. They were actually from British Columbia. So the tax rates are slightly different. But I’m going to use Ontario tax rates specifically because ours are usually like the more painful of most provinces. Although there are a couple exceptions.

They have like normally if let’s say they had a net operating income in their associated operating companies of say $400,000, they paid 12.2 % tax on that 400,000. They pay this big tax bill and let’s say it was the same every single year, their installment payments that they’re making would cover the taxes and there would be no surprises. Now, even if they earned an extra 100,000, they’re still

under the $500,000 operating net operating income amount, which means they pay an extra $12,000 or so in unexpected taxes on that $100,000. Right? So it’s not fun. Nobody wants to pay that. However, if they earn more than that $100,000 compared to the $400 they had learned earn the previous year, they now creep into a higher tax bracket, which means not only are you paying

more tax on more dollars, but you also get invited into the world of, my gosh, you are really successful and therefore you no longer need the small business tax credit, which is why we pay such a low amount on the first $500,000. So you’ve now crept in, you’ve got kind of two problems. We’re now paying more tax on more dollars, which again, good problem to have, I have more profit, but now my tax rate just went up and it more than doubles.

Jon Orr: Yeah, I was gonna say like you made, let’s say you made $600,000 on the next 100,000 after your 500,000, that last 100,000 that puts you up to 600,000, you’re not now paying $12,600 in tax for that $100,000, you’re now paying 26,000, like you’re doubling the tax you’re paying on that extra money, so you’re losing more of it into that territory. Like you’re saying, it’s…

it’s hey, we’re doing better, we’re gonna pay more tax because we’re past that small business tax credit. And this is where, you know, where some creative options start to come into place to think about how do I get back under the $500,000 limit if I’m close? Like if I had a banner year and I blew it out of the water, then you know, you’re living in that land. there are some, say, thresholds that you can start to look at that can help you kind of

think about bringing that back down as as expenses that can creep in. So I think when we think about like, are expenses that I can, this is this is where businesses start to go like, well, let me buy a car or let me you know, let me let me get this and it’s, we talked about that just recently on a previous episode is that, you know, are you are you using expenses for expenses purposes or using expenses to buy assets? And if you’re using expenses to buy assets, and you’re making good financial decisions, then go for it.

So you want to be watching that. But you know, the way that this the suggestions that we we went with with this particular couple is we looked at how much you pay in yourself. Because some some businesses and some business owners, especially incorporated business owners think that maybe I should just pay myself through dividends. And all of sudden, it’s like I’m going to, that’s how I’m going to get my money and pay dividends because I’ve heard the dividends, you know, you know, you can you can earn more money if you pay yourself dividends. But if you’re not taking, say a combination of dividends and salary, you may be missing out. So

Let’s talk about that, Kyle. Let’s talk about what was this, what were these clients paying themselves? What was the payroll structure? What were they thinking about? And then what did that shift into to help them save for the future?

Kyle Pearce: Yeah, so for this particular couple, both of the spouses were actually being compensated from the operating company. So that’s a good thing. So they were both actively involved in the business, which is great. They were taking about $72,000 in salary and sometimes taking some dividends when they needed the extra money. And in a lot of cases, I would say like that’s a good number. That $72,000 mark we talked about in the past.

That means you’re, you know, you’re, you’re max contributing to CPP. We can argue and have a complete different episode as to whether it’s worth it or not worth it. Return wise, I can do better than CPP, yada, yada. Is it safe? Is it not? CPP isn’t going anywhere. And again, for the small amount that you’re contributing towards it, in our opinion, it’s a nice little diversification play to have once again, another bucket available to you that you don’t act, have to actually like turn the gears on. So

That number was good and it kept their personal income taxes at a reasonable amount. Now, and it was enough for lifestyle for them, which is fine, right? So yeah, very important. But then there comes a time where all of a sudden we have to start doing the math and going, well, wait a second. If I’m now, and you talked about the banner year. It’s like they unfortunately had a banner year for their operating companies and put them over $500,000 of net operating income last year.

while the banner year is happening, we’re recording this in the middle of the year, it’s June, 2025, as we record this. If you are in June and you’re recognizing that this year is going to be a banner year, this is when you wanna start discussing and thinking about what do we wanna do here? What can we do in order to try to deal with the additional taxes? The one thing I can promise you is that,

You’re still going to have to pay more taxes. You’ve earned more money, right? That’s not something that we’re going to avoid. But the question is, what could we have done to potentially put the dollars in our personal pocket, maybe pay around the same in taxes, but now it’s in my personal pocket, instead of being retained earnings inside the corporation unnecessarily, right? So when we look at this and we go,

At $72,000, I’m not in a huge tax bracket yet, right? I’m in a nice tax bracket. However, if my company is going to, let’s say on the last $100,000 of net operating income, if they’re going to be paying 26 and 1 % here in Ontario on that $100,000, wouldn’t you rather try to get

most of that money into your personal pocket if you can. And you might even sacrifice paying a slightly higher tax rate personally, just to have rescued some of those dollars. We’re not gonna rip the bandaid off and rip it all out. Because remember the 12.2 % on the first 500,000, that’s like the real win is the savings, the tax savings on those dollars. Once we get above $500,000, we can start thinking about, hey, wait a second, if I’m taking a dividend, in order to pad my personal income, I’ve actually done myself and my business a disservice by not taking advantage of a salary, right?

Jon Orr: Yeah, I was, I was, yeah, I was thinking about those logistics right there, right? Like if we, if they continued on the 70K each a year and they’re over the $100,000 and then they’re like, you know what, we need a little extra money as we’ve always done. Then let’s issue a dividend now. And so you’re, let’s say it’s coming, you know, it’s coming off the top. The top is already passed. You’re into the 26.5 % range of tax that you’re paying. So,

the dividends come after tax, right? So they come as like you issue dividends after, from your retained earnings. So it’s like, okay, so they pay themselves $70,000 each in payroll, which is an expense that brought us to this level where we’re still in this tax bracket that’s higher than previous year. And so now we’re going to issue dividends, but now we have paid tax at 26.5 % on the money that we’re going to now use as dividend money, which means like that was taxed

at that rate so that I could get it to send it to myself, but myself, I’m not paying 26.5 % in tax yet. So I’ve paid more in tax at the corporate level on the money, but then I also am gonna get taxed at the personal level. And I think with that money. And so it’s kinda like, ugh, like maybe what we could have done was paid ourselves more in payroll to get access to that money, which may have brought down

the expenses under the 500,000. And then I’m now taxed at that, which means like there’s a threshold here. Like, know, mathematically we’ve, you know, our heads go to that is like, where’s the break even point here where that I pay myself a certain amount, but my tax rate at my personal level, when is that tax rate at the corporate level 26 point, like what’s my personal rate getting to 26.5 % so that no matter where that money flows, whether it flows out,

in payroll or whether it flows out after tax at the corporate level into my pockets because I got it out of my business in terms of a dividend, what’s that floater number? Like what’s that payroll number that helps me like manage that so I don’t like lose out on one end or the other?

Kyle Pearce: Yeah. And every province is going to be a little different, right? As we know, right, there’s different tax rates. But, you know, for us here in Ontario, it’s like you’re, you’re at like just under 26 % on average. We’re not talking about your marginal tax rate here, but the marginal tax rate can be helpful if you didn’t need this money. And then it might be worth using the RSP as a way to get that money back. So we’re not even going to consider the RSP at this point in time.

If I take 135 and like, let’s pretend for a second, I wave a magic wand and my net operating income before paying salary was $635,000. You can see where I’m going here. $635,000 $135,000 of the net operating income is going to be paid at the higher tax rate. And therefore it would make sense if I’m going to take, if I could take 135 out and pay a

about the same in tax personally as the company would corporately, you might as well take it out, right? Take it out. You could utilize the RRSP if you wanna benefit, cause you know, here in Ontario, your marginal tax rate at 135 is gonna be 43%. So you get kind of like a net win here in that the money would, we’re gonna lose 26 and a half percent to that 135 in the corporation and that’s it. Or,

I could pay the same amount in tax over here, take a bucket of that, dump it in my RSP, let’s call it maybe 30 grand or whatever, into my RSP, assuming there’s enough room, and I could get 43 % of it back. In that case, it makes sense. Like you’ve heard us say on other episodes that we don’t want to unnecessarily utilize the RSP, especially like if I’m only taking $72,000 a year out and my company’s only netting.

under $500,000 of net operating income at the low tax rate. I don’t want to take extra money out to stuff the RSP at this stage. I want to save that opportunity for when I get into this situation where I go, Hmm, things are looking good and I can now create an expense in the business net out on taxes and then actually be ahead for now. If I utilize the RSP in that specific situation,

Jon Orr: Okay, clarify a number for our listener here because, you know, on one hand you’re saying like, you could leave it in there and pay 26.5 % on the tax, but then you take it out and all of a sudden your tax rate is 40 something percent. Like to our listener right now, they’re like, wait a minute, isn’t that mean more tax?

Kyle Pearce: Yeah, well, what I like to do is I like to think about the average tax rate I’m going to pay because really what that is, is that’s the total amount of tax you’re paying on the whole sum. So it’s like takes in the different brackets, it kind of puts it together and weights it all out. And basically what it’s saying is, listen, if I take 135, my average tax rate in Ontario is 25.95%. You’re actually going to save on the full 135. You’re going to save a tiny bit of money in doing so.

Now, of course, you can make it perfect. Again, going a little higher, a little lower, like totally up to you. It’s not about being perfect here. It’s just about having an awareness. The marginal tax rate, the last dollar I took out of that 135 was taxed at 43%. But remember, the first dollar was taxed at 0%, right?

Jon Orr: Right. Yeah. Yeah. So we just got to remember that, right? So the fact that he said 40-something percent doesn’t mean like all of your money was taxed, but the average was taxed about the same as what it would have been inside the corporation to bring it when it was over that 500,000 threshold. So the magic number here, one of, like there’s a number of magic numbers. For payroll purposes, if,

If you are close, if you’re thinking about like, is my corporation made more than $500,000 of net income this year? Is there a way where my payroll makes sense to adjust my payroll, maybe a key member’s payroll, to bring those expenses higher that can then bring you closer to the $500,000 and the key number here to look at, because it might not be right for you.

But the key number to look at is 130 because that’s where the amount of payroll is, you the amount of personal income is exactly the same as that next $500,000 of income. And so it’s like, that’s where that kind of number lies. So that’s where the 130,000 is coming from is that if you made that on the personal side, you’re paying, like Kyle said, almost 26 % tax overall average, but that’s what that money is taxed at anyway over in the corporation.

Kyle Pearce: Yeah, and I want to just give like a really explicit example. It’s not saying it’s the best move here or you know, it’s it’s the move you’ve got to make. But if you’re that person, you go this hundred and thirty five thousand is going to get taxed at twenty six and a half percent in the corporation. What’s left in the corporation at that time is going to be about one hundred thousand dollars after you pay tax. Right now, you will if you did take it out as a dividend, you’re going to get to pay on

eligible dividends instead of ineligible. We’re not gonna go down that path today. That’s just a way to try to offset some of the personal tax. But here, if we can expense that 135, take it personally, you’re gonna have the $100,000 in your personal hands after tax. If you took $20,000 and put it into your RRSP, okay, now keep in mind,

Jon Orr: Right, because they didn’t need it because they only needed $70,000 each.

Kyle Pearce: They only needed 72 and that was 72,000 before tax, right? So it’s like, you know, they had even less in their hands. So now they’ve got a hundred in their hands. They take 20,000 of that. They now have 80 in their hands. They still have more after tax in their hands than they did when they were taking 72 and they put that 20,000 into the RSP. So now it’s like, you’ve now said, sayonara to that 20 for now. You put it in the RSP. They’re going to get about.

$8600 back. That’s going to give them a total of about like in after tax dollars. Like when you add the money in their hands, $80,000, the $20,000 that’s in their RSP, which is now not cash flow. Like they can’t spend that money right now, but they can buy assets. They then get an $8600 tax refund.

at income tax time. So now in their pocket, supposedly, they’ve got like 80, you know, $88,000 in their hands, plus they’ve got 20,000 that they can invest in the RSP, noting that, remember, on the way out, though, that 20,000, whatever it grows to tax free, 100 % of those dollars are going to be taxed at your personal rate. So it is worth noting, and it is worth you know, if it becomes a

I always say it’s a good thing to have. It’s a good problem to have if your RSP gets too big that you got to deal with it at that point, but you should just be aware of it so that if it does balloon to too big, maybe you start utilizing some other strategies on top of this one here today.

Jon Orr: Sure. So what did these clients end up deciding to do?

Kyle Pearce: Well, unfortunately, there’s nothing they can do about last year because again, this is where it’s like, but, the question and the, the sort of discussion we had was, do you anticipate to have a similar net operating income this year? Was that a fluke last year? Is it something that is it going to continue growing? And because they believe that they’re going to at least stay consistent or grow, now’s the time for them to adjust.

their salaries so that they can take advantage of this during 2025 so that again the tax is going to have to get paid but where do we want the money to fall afterwards and in this particular example we’ve given you today more money falls on the personal side of what we call the corporate border which is really always the win right like we want to be able to get it back there you can still take that money you can lend it to a holding company if you

don’t want the liability of having too much money or assets in your personal name. There’s all kinds of ways that you can do things in order to sort of protect yourself from having too much personal assets. But like I say, it’s like the biggest problem most people have is that they have too many assets that are essentially trapped in the corporation. And what we’re doing today is we’re giving you an opportunity to help get more of those dollars out in a more efficient manner. so that you don’t have as big of a corporate retained earnings problem down the road.

Jon Orr: Yeah, yeah, the strategies that we’re talking about here, when we think about Kyle, the beginning of this said that he was helping these clients with their financial planning system and their financial plans. The, you know, the system, the plans, they, in our, in our opinion, the what we’re trying to do with our clients is to help them understand about the four different phases, the four different stages of a healthy financial system, either in your

corporation, your business, or in on your personal side, we believe that those same four stages exist. And so what we’re talking about here is really the optimization stage, which to us is stage three. So stage one is our is our vision, our goals, like we have to be very clear about where we’re trying to get to. That’s usually, you know, setting some parameters, some targets, but also

Creating the program creating the plan to get to these particular targets and it’s like very detailed and what we’re trying to help our clients get to so the clarity is there so that all the other pieces fit together the stage two is every successful plan incorporates a wealth reservoir and so our wealth reservoirs have Taken different structures from different pathways, but we all know that having our emergency fund our opportunity fund our capital funds

are essential for a healthy system, healthy growth, we have to make sure that we’re creating those opportunities and those emergency funds. So that’s stage two, we have to kind of focus on that. Stage three is about that optimization stage. And today, those are some of those strategies. It’s like when we are incorporated as a business and we are taking salary from our businesses, how do we optimize some of those structures, some of those pieces? There’s a lot of nuance to that. And every time that we’ve had these discussions with our clients,

even though they’re the same rules that everyone has to live by, they’re all different by that client. It’s very customizable because we all have different constraints and different systems. that’s a lot of the work that we do when we meet with our clients is to talk about those types of strategies when we have our vision set, when we have our reservoir ready to go. Like those are structures and almost like they’re not tangible, but they feel tangible. Whereas strategies over in stage three are very much catered to that particular client. And then stage four,

is when we start to go, okay, we’re optimizing currently, we’re optimizing for the future, but then we’re also optimizing for the future for our legacy and our state planning. Essential component of a healthy system is to make sure, like Kyle said, it’s like, hey, what’s gonna happen when retirement comes? Because I stuck a whole bunch of money in the RSPs from payroll for over the course of 30 years. Like we do wanna take into account what that looks like down the road, which is very much related to all the other pieces, the other stages.

So that’s why we have to get clear on stages one to three. And then we can get really clear on what to do in stage four, which is your legacy and your state. If you want to know more about those four stages and where you fit and want some of the guidance on those four stages, we’ve got a full report that we can give you, customized report. Head on over to CanadianWallSecrets.com

after you fill that out, will be emailed a custom report that’s built for you with some next steps. And some of our folks will be, you know, being given the opportunity to hop on a call with us so that we can walk through their own report with them and we can guide them in that process. You can also do that over at Canadianwellsecrets.com for just discovery. If you would like us to help you navigate this pathway for you, go on over there and book a call with us so that we can steer the way through these four stages.

Kyle Pearce: All right, wealth secret seekers, enjoy your day and keep on seeking. And just as a reminder, this is not investment, accounting, legal, tax or financial advice. It is for education and entertainment purposes only. You should always contact your advisor and your fiduciaries.

I, Kyle Pierce, am a licensed life and accident and sickness insurance agent, and I’m the president of Canadian Wealth Secrets, Incorporated. And we look forward to seeing you in our next episode.

Canadian Wealth Secrets is an informative podcast that digs into the intricacies of building a robust portfolio, maximizing dividend returns, the nuances of real estate investment, and the complexities of business finance, while offering expert advice on wealth management, navigating capital gains tax, and understanding the role of financial institutions in personal finance.

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