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Description:
If your corporation earns $250,000 of net operating income, are you asking the wrong first question about how to pay yourself?
Most Canadian business owners turn to YouTube or their accountant and get stuck on “salary or dividends?” But that’s usually the second or third question. If you’re sitting on profit in your corporation and aren’t sure how much to take out, how much to leave in, or how to talk to your accountant about it, the order you make these decisions in can change your tax bill and your flexibility for years.
In this episode, Jon Orr and Kyle Pearce walk through the four ways to pay yourself from your corporation, using a $250,000 net operating income case study. They show why your lifestyle number comes first, how CPP and RRSP room affect the salary vs dividend choice, and how the capital dividend account lets you take the tax-free portion of a capital gain out of your corporation. You’ll leave with a roadmap for a smarter conversation with your accountant.
You’ll discover:
- Why your lifestyle number is the starting point for deciding how to pay yourself, and how an effective tax rate around the small business rate can guide the minimum you take out.
- How CPP costs, RRSP room, and the flexibility of keeping money in the corporation shift the balance between salary and ineligible dividends, depending on your income and how far along your business is.
- How the capital dividend account works for corporate capital gains, and why the RRSP has no equivalent, so you can diversify across buckets instead of going all in on one.
Press play now to learn how to build a confident, tax-aware plan for paying yourself before you sit down with your accountant.
Next Steps:
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Canadian Wealth Secrets Show Notes Page:
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 corporate passive income taxes at greater than 50%; or,
- …wondering whether your current corporate wealth management strategy is optimal for your specific situation.
For Canadian entrepreneurs wondering how to pay yourself from your corporation, the best Canadian wealth plan starts with your lifestyle number, not the salary vs dividends Canada debate. If your net operating income is around $250,000, there are four ways to pay yourself: salary, ineligible dividends, eligible dividends, and the tax-free capital dividend account. Each affects your effective tax rate, your CPP contributions, and your RRSP room, which is why personal vs corporate tax planning matters. Keeping retained earnings in the corporation under the small business deduction supports tax-efficient investing and corporate wealth planning, while RRSP optimization and optimizing RRSP room add a second layer of deferral. A financial bucket or investment bucket strategy helps you diversify across the corporation, your RRSP, and non-registered accounts, including real estate investing in Canada. A capital gains strategy lets you use the capital dividend account to pull the tax-free portion of gains out of the corporation, while corporate structure optimization and estate planning and legacy planning in Canada protect what you’ve built. Whether your goal is financial freedom in Canada, financial independence, an early retirement strategy, or modest lifestyle wealth, financial vision setting, retirement planning tools, and passive income planning help you build long-term wealth in Canada. With the right corporation investment strategies and Canadian tax strategies, financial systems for entrepreneurs can turn Canadian entrepreneur finance into real business owner tax savings and financial diversification in Canada, whether you’re weighing real estate vs renting or planning your next move.
Transcript:
Jon Orr: Here’s the question we are going to answer today. if I have two hundred and fifty thousand dollars of net operating income, how do I pay myself from my corporation? That’s that’s a c that’s the question that we were asked, I think, twice last week on our on call, strategy calls with Canadian business owners. And and one of the people that we were discussing this with said, and they went as far to say as look, look, I I I went to YouTube.
And I typed in, how do I pay myself from my corporation? and there’s, you know, there’s a lot of videos out there. And every one of those videos breaks it down in terms of salary or dividends. And I think what we’re going to kind of shed some light on here today is that in a way, if you’re asking yourself, should I take a salary or should I take a dividend, we believe that this is kind of the the wrong first question you should ask yourself.
And and I think it’s maybe the second or the third question you should really be asking yourself. But specifically what we’re going to be unpacking is understanding the four different ways to pay yourself and how to think about those and how to start. And by the end of this episode, you’re going to have a a roadmap on how to think about and and structure and have conversations with your accountant on how to optimally pay yourself if you have two hundred and fifty thousand dollars of net operating income in your business. Let’s get going.
Kyle Pearce: Awesome, awesome. Yeah. So this is something we talk about all the time. And to be honest, every situation is different.
And there are other questions that we need to be asking ourselves, thinking about things like runway and thinking about, you know, where your assets currently lie. Do you have a lot in the corporation? Do you have a lot personally where you could maybe push off more in the corporation for longer? So there’s a lot of things we can do.
But ultimately, when we’re talking about the small business owner who has not
Breach through the small business deduction number of 500,000 per year. That’s why we picked 250. We kind of like put it somewhere in the middle there. What we’re gonna have to figure out is like first and foremost, is how much money do we need for lifestyle?
And then we can start looking at the pros and cons of taking it out as a salary or a dividend. Now, although there are
Four ways to take money out. The reality is two of those ways are types of dividends. And one of those is actually not going to be accessible to you if you’re only earning $250,000 of net operating income. What I mean by that is we have something called ineligible dividends.
That is what you are earning or you’re building up a number of opportunity. They call it
Credit towards your ineligible dividends that you can pull out. When you are above the $500,000 mark, you are actually generating the opportunity to take out eligible dividends. And really, the difference maker there is that really they’re trying to calculate in the CRA is basically trying to figure out how much tax have you paid? If you paid tax at the small business rate, then
We want to tax you more at a personal level if you take out those ineligible dividends. And if you’re paying at the high rate above $500,000, you’re going to be in the high or the general rate. You are going to get the opportunity to take out eligible dividends. So when we’re in this zone, like we’re basically discounting the opportunity to use eligible dividends at all, unless you are invested in the corporation, in other public.
companies that are sending your corporation eligible dividends. So we’re going to assume that’s not the case here. And we’re just talking about money that you’re generating for your, for yourself in today’s discussion so that we can really kind of get to the the bottom of this here.
Jon Orr: And and here’s a couple things that we are going to make some other assumptions on. And and and one assumption is we’re not we’re not sharing specific strategies on benefiting from the expenses side. Okay. So that’s one area we’re not touching here.
So that’s like that’s like the hey, I wanna I’m gonna take a client I’m gonna I’m gonna use air quotes here. I’m gonna take a client out for dinner and that’s an expense. And and some people might be like, Well, that’s a way to get money out of my business. Like that’s not where
We’re not we’re not going down that land, or that that road in this one. And then it’s we’re also not going down that road in this episode on, you know, like expensing down to zero. so you have no retained earnings. We’re talking about there are retained earnings or there are there is net operating income here.
We legitimately want to decide how do I pay myself when I have profit in the business. and I now need to decide that. And so we’re not gonna kinda go down those lands, like you you’re you feel free to explore those yourself, but in specifically
In this episode we’re saying, well, how do I do that using salary? How do I do how and should I? And what what about dividends? What about the other ways that you guys just mentioned?
so let’s get into that then, Kyle. Where do we where do we need to begin? ’cause I said s you know, asking yourself whether it’s salary dividends was the second question. So how do we how do we start thinking about this?
Kyle Pearce: Well, I think we want to start thinking about how much money do we actually need in our own pocket. So I would argue the less money that you need at a personal level, the more you might start getting creative about whether you do want to take a salary or a dividend, right? And one of the biggest pieces here that’s going to sort of factor in is deciding. Cause here’s the reality. For you, if you have a net operating income of 250,000.
Want to be clear, we have not paid ourselves from this 250,000. And we’ll explain why that matters in a moment. But if we have that same amount of quote unquote profit before paying myself as the owner of the business through a salary or a form of dividend, we are in a position where we have to decide like how much do I need for lifestyle? And the reality is, is whether I take a salary or dividend.
In this case, I’m only able to use an ineligible dividend in this particular case. I’m going to pay about the same amount in tax. The difference maker here is going to be the CPP number, whether you value CPP and whether it’s worth you actually accumulating those CPP credits. The lower your net operating income, the more I might maybe push you away from a salary because you’re paying into CPP twice.
And the more net operating income you have, the more I might push you towards a salary because you have enough income coming in where that value for CPP is sort of not really mattering a whole bunch. So we really want to sort of decide on how much do we need for lifestyle? And then from there, we want to decide like, what are the plans for the other dollars and where might they best sit?
when we are trying to invest and grow our net worth for the long term.
Jon Orr: And so if I’m if I’m th so I need to know what is my personal expense level and what do I need to live on? that’s the first question. Then I need to go, okay, I’m going to decide here whether I should pay a salary dividend. You’ve given us a case to say like you if you are val you know you said value the CPP to choose salary, knowing that
We’re gonna pay the CPP on both ends, between personal and on the corporate side. like how how do I think about that? And like like like how do I how do I help myself? I’m the let’s let’s imagine for me for a minute, I’m the listener here.
I’ve decided determined how much I I need to live on. I’ve got excess. How do I think about deciding between a salary or dividend? Do I just am I just waiting for my accountant to figure this out?
Or how how do I wanna think about this going into an accountant meeting?
Kyle Pearce: That it’s a great question. I I think it really has a lot to do with what you anticipate the runway to look like for your business as well. So is this business going to stay earning about the same amount and then deciding on where do I want these dollars to fall? And that’s going to be really important because the magic number, at least here in Ontario, but in most provinces across Canada, is that if you only require, say, 40-ish thousand dollars for lifestyle of pre-tax dollars, so
Talking about this is the magic number. If you took a salary or dividend of about $40,000, you’re going to pay an average tax rate, an effective tax rate of around the same amount as what the corporation would have paid on that net operating income had it stayed in the corporation anyway. So if you don’t need that money, you still want to take that 40 out minimum. That’s going to be, you know, sort of every single individual. We’re going to want to do that anyway.
Most people, if this is your actual only income source, are probably going to need more than $40,000 a year. I can’t speak for everyone out there, but it is expensive, especially if you have a family, kids, and all kinds of other responsibilities as well. So it may be unlikely that you only need $40,000, and therefore you have to start creeping up. And I would argue that as we creep up, what we’ll get if let’s say we need somewhere around like $80,000 to take out of this corporation.
Why I tend to try to get people to at least consider taking the salary is because you do get to fully fund the CPP. While it’s not going to be a great value for you as a business owner, you also get the RRSP room that’s being generated. Now, you may not use that room in that given year if you’re only taking 80,000 out. It may not be quote unquote worth it for you to use that room.
Now, especially if you anticipate that the business is going to continue growing and growing that net operating income up and up from where it is now. I’d like to see some of that RSP room, if possible, utilized in later years when let’s say you’re above that small business rate, where all of a sudden now the deferral in the corporation is right now, you’re partially deferring some tax. You’re going to pay like nine to 12% for money that you keep in the corporation.
Whereas money we put in the RSP is going to fully defer. So right now, like going from a 0% to a nine to 12% is not like a huge difference. And I would argue that there’s more flexibility in the corporate structure for your investments than say in the RRSP, where there’s only one way out and taking that as a salary. There is no way to get any of those dollars out in a more tax efficient manner unless we’re using more advanced, say, leverage strategies in the future.
So for me, what I like to do is I always like to consider if I have enough net operating income in the business where the total amount of CPP, which is usually around $9,000, you pay half of it personally, you pay half of it corporately. If that $9,000 is inconsequential to your overall plan, then let’s go pro salary. We’re going to get the RSP room, which could be incredibly helpful for later.
Jon Orr: Mm.
Kyle Pearce: Or it could be helpful in that tax year if you’re taking a lot of money out of the corporation. Whereas if I take a dividend, what I’m doing is I’m saying the RSP room isn’t that important to me. And I also care about that $9,000 that I would rather do something else with, likely in the corporation. I’m going to take that $9,000 and maybe invest it into growth investments inside of the corporation. Maybe it’s real estate, maybe it’s a managed portfolio, maybe it’s ETFs.
Whatever you choose to do there, we can defer that over there or partially defer some of those dollars in the corporation. And I’m giving up my opportunity to earn CPP credits in that given year.
Jon Orr: So is it like what’s your opinion? Like basically saying like we need to determine w what we need to live on. Anything excess, we need to decide where it where it goes. And so like if I decide that I need I need let’s say a hundred thousand, like you said, eighty hundred, hundred and twenty to live on, going salary is a is a good choice if I want to start making sure that RSP room is created, whether I use it or not is not the case, but whether I’ve created it.
and then therefore I could start investing when I need it on that side of things, which is a f form of kind of deferring and getting money out of your business at a optimal tax rate, but then pushing it aside for later for later use. CPP is not let’s say a major, you know, it’s it’s it’s something that I value, but it’s not a major line item in terms of comparison to my salary or my corporate, you know, profit. so
Those are some conditions I’m looking at, but but I guess when I think about the like leaving the excess money in there, is the is the is there any value to paying ourselves more than what we need to do some of these things anyway? Like it like it I think what we get caught up in is to go, look, well there’s two hundred fifty thousand dollars of retained earnings in there. I need a hundred. I’m gonna pay myself a hundred by salary, so it’s gonna reduce my taxes on the corporate side.
I’m okay with CPP. I’m not I’ve got my reta should I pay myself more than that to fund more of the RRSP? is that a good move for me? And or like, or should I just always defer by leaving my money inside the corporation and use it to invest inside the corporation as its own kind of in a way sheltered protection for the for the future?
Kyle Pearce: Well, and one thing I will say is like if you do need more money coming out of the corporation than say the 75 to 80,000 per year, I almost always, almost, I always leave myself the reservation for, you know, there’s always an exception to the rule. But when it’s above 80,000, like that’s where you’re gonna max out your CPP contributions. That means every dollar above 80,000 is just R R SP room that we’re getting. So remember.
I’m gonna have to pay the tax somewhere. I either have to pay the tax personally or I have to pay the tax partially personally and partially corporately if I’m gonna pay myself more via a salary or dividend. So if I’m paying more than the 80, now I’m starting to like care less about the CPP thing because now I’m getting extra RSP room. And I would argue the more money that I need to live, the more I want to have that salary. Remember, I get.
Contribution room up to about $185,000-ish in 2026 for the RSP. So I might as well take it. Whether I choose to use it or not in that given year is another question. Because here’s the deal: if I’m in the low you know, small business rate at as a business owner, remember, any extra dollar I take out of the corporation, I’m gonna get taxed at my personal rate.
And it’s going to be significantly higher than what I paid in the corporation, that nine to 12%. Because remember, we’re still in small business rate land. Okay. So while it feels like the extra dollar coming out is giving me a lot of tax back, because that last dollar might be taxed at the 40% rate or whatever it is as a salary. Remember that dollar, if you kept it in the corporation, would have only been taxed nine to 12%.
So you made a choice to instead of paying 9 to 12%, take the dollar out, pay temporarily like 40-ish percent on it. So I’m not paying nine to 12% in the corp. And then only once I put that dollar in the in the RSP do I get all of it back. So yes, you still save nine to 12-ish percent in tax in that scenario.
But do keep in mind that now there is less flexibility for those dollars coming out of the RSP. So
Jon Orr: Mm.
Kyle Pearce: When we’re still dealing in small business deduction or small business rate land as a business owner, these decisions become a little bit more nuanced because again, the gap, the deferral that you’re getting in the RSP versus the corporation are a little different. Now, I want to give you an example here. If I’m a brand new business owner, so this is something we didn’t talk about at the top of the episode. I got about $250,000 of net operating income before paying the shareholder.
All right, that 250,000, but it’s year one of my business. I’m less likely to want to get too aggressive putting more dollars in the RSP in that year because it’s likely that you’re like, I just started this business and I need a little extra cash on hand. I don’t want to be put in the position where I put money in the RSP, I save the nine to 12%, because that’s really all you’re actually saving around trip here. Nine to 12%. And then
Let’s say something doesn’t work out in the following year for the business. And then now you’ve got to pull money out of the RSP. You’ve lost the contribution room. So you have to re-earn more contribution room.
I can’t put the money back in and reuse the same room. It’s like I’m taking it out permanently. I lose it in order to maybe fund the business or maybe fund my lifestyle because the business business didn’t do so well. However, on the other hand,
Once I build up enough retained earnings in my corporation, I keep more money in. I’ve paid a small amount of tax each year, nine to twelve percent on those dollars. Now it opens up the door to go, you know what? I like the idea of maybe starting to put some in the RSP so that we have the diversification of buckets that we talk about on the show quite a bit. So I would say the earlier you are in the business journey.
If you are a small business owner, meaning that you are less than the $500,000 of net operating income number and you’re just starting out and you’re in the first few years and you don’t have a ton of extra capital floating around, I’m probably going to hold off on the RSP room. I’m going to want to gain that credit, especially if I’m taking more than $80,000 out per year for lifestyle. Let’s stack up those credits so that I can utilize the RSP once I have a little bit more.
flexibility and a little bit more liquidity inside the business. And we can actually start doing some of the longer term planning in the business in that particular case, at least for the time being.
Jon Orr: At the top of the episode we said there was four, you know, w four ways we’ve been talking specifically about salary for the last few minutes here. We we kind of briefly touched on non-eligible dividends, eligible dividends, which we kind of also said are are for when we’re making more than the case study we’re kind of exploring here today. So that third that third technique we’re we’re we’re gonna talk about in a different episode. but in the when we go back to say non el eligible dividends, is there
Is there a case because what I think what you’re I hear you saying is to saying like if you’re need to take out a good chunk of money to live on or because you want to make use of some of these government benefits, then salary is a good move. Is there a case for blending salary and dividends?
Kyle Pearce: I would say if you needing more than say a hundred and eighty-five thousand dollars to take out for lifestyle. Now, the problem here is like we’re getting closer and closer to this two hundred and fifty thousand dollar net operating income that we haven’t paid tax on in the corporation or personally yet. Because remember, we’re assuming we haven’t paid ourselves yet. So what we’re seeing here is like if we’re in that scenario with that net operating income number before paying ourselves.
We are getting closer and closer to a point where you have to start questioning whether from a tax efficiency standpoint, whether the corporation is actually helping at all. Because if I leave nothing in my corporation, then the only thing I’m really gaining for now is an extra accounting bill and also some liability protection, right? So I am I am protecting myself. But if I’m not leaving any money in my corporate structure every year, basically I’m getting the full tax hit and then.
The only other exception to the rule here is if some of that money was going in fact into the RSP. but again, we’re talking about needing this money for income. I would probably take the income or the salary of up to 185 or 190. whether you go a little higher or not, like, you know, would be pulling straws here. It’s not really, doesn’t really matter a whole lot.
Jon Orr: And that’s because that’s where R R S P starts to to like you hit your break even or your not your break even but your kind of boiling point there for for RSP contribution.
Kyle Pearce: Exactly. And and basically what you can do is at any time you can pull this extra dividend and you’ll pay tax on the dividend at a personal level at the end of the year. So another negative that we haven’t talked a whole lot about on previous episodes is when you do take a salary, one negative is that you’re actually giving the the government their tax as you pay yourself throughout the year. Whereas with a dividend, you pay at the very end. Now
From an optimization standpoint, it makes sense to wait to pay tax because now you have the money in your own hand. Whether you took that money and put it into, you know, a savings account or into a GIC or into money markets or even into something a little bit more higher risk, higher volatility, you could make money on that tax money, but then you get the tax bill at the end. And what we find is most business owners don’t do well with that. Like they end up getting themselves into trouble and they go.
Jon Orr: Crap. Yep.
Kyle Pearce: I’ve lived off of my dividends that I took, but I actually didn’t put any money aside to pay the tax. So now what do I have to do at the end of the year? I got to take a bigger dividend to pay for the tax. And then what we get is to a bit of a snowball effect, right?
Where they start, you know, they didn’t think they were spending that much money, but now they are. And, you know, they’re kind of going downhill. So I like the salary from the budgeting aspect of it, even though it’s less efficient. I like it because the RSP.
I’m not in, I’m not a huge fan.
fan of the CPP aspect, especially when we’re starting out, because every dollar matters. But as your business becomes more consistent, as you grow your pile, that $9,000 a year, John, you and I, we pay ourselves salaries because, you know, it it doesn’t, we don’t notice that $9,000 for CPP. So it’s a little extra bonus. We are getting half the value that a typical T4 employee would get. So
It’s not a great deal, but we do value the RSP contribution room. We like having that flexibility and we do utilize it because we are earning enough inside our corporate structure where we can actually diversify across different buckets. So we have you know, an enough, we’ll say, inside the corporate structure, but we also utilize our RSP room as well. So we look at both and we see it and
You know, you and I are at a stage two. We’re looking at IPPs and we’re looking at different things depending on the runway of how long we want to operate our businesses. So these are all really important discussions. But when we’re starting, I would say small and when we’re early in the journey, you know, creating that RSP room to me is helpful, but not if the $9,000 for the CPP is going to be like.
You know, is is it’s gonna feel like a real big pain in your side, then maybe you’re holding off. You you go with the ineligible dividends. If you have a big lifestyle need above $80,000, let’s say it’s up to $180 or $185, then if you need more than that, you could keep taking more salary. It’s not gonna quote unquote hurt you, but I’d rather you top up with a dividend so that if you don’t need that money, you don’t take it.
So it’s like you you budget for 185, that’s coming out every two weeks or every 15 and 30, depending how you do your pay schedule. And then if by the end of the year you’re like, we are kind of thin, I need to take a little extra, you can go ahead and just take that extra dividend. And ultimately at the end, you’re gonna pay a smaller amount of tax at a personal level on those dollars. But there’s there’s no tax advantage to doing so.
So I want to be very clear here. It’s not like, well,
Jon Orr: Got it.
Kyle Pearce: You know, Kyle and John said at one eighty-five, then we take a dividend and they all call their account and their accountant goes like that it doesn’t it’s not gonna actually matter. It actually doesn’t from a tax perspective. You’re not saving a whole lot. Like it’s we’re talking within a percentage point of the saving. They try to get it bang on if they can using integration.
Jon Orr: So when we think about these two vehicles, salary and dividends, you know, we’re thinking about what is our lifestyle number. then I need to know the spread, which means like what does it look like after I pay myself either the salary or the dividend? I do if I’m paying myself a salary, what’s that that what’s that spread that’s left in the business that’s is gonna be taxed? How do I wanna think about that? I do need to know how much I really need and I can start optimizing after
that. So those are kind of the two dials to think about for sure. But let’s talk about the fourth kind of technique here. because we generally think about salary and dividend, but but talk to me about the cat like capital dividend.
Kyle Pearce: So essentially there are only two ways, like salary or dividend. The difference, so as we described is there’s like these three different types of dividends we could take. So small business owner, you’re pretty especially when you’re first starting out, you’re pretty much limited to salary and dividend, an ineligible dividend. However, if we’ve been growing our retained earnings, so if let’s say, you know, you chose to grow inside the corporation a bucket of capital.
The idea is that we could invest that capital and we can do it in a number of different ways. We could buy real estate and hopefully the real estate grows in value. We can buy stocks or equities, hope that grows. Private equity, we can do all kinds of different things. But the key is that when we get a capital gain inside the corporation, just like when we own it personally inside a non-registered account or a non-registered holding of any type, we actually get the same benefit.
That you get outside of the corporation, which is only having to pay tax on half of the capital gain. So that’s a really important thing. And how they track that is through a capital dividend account. So the capital dividend is basically where you’re going to pay yourself out the tax free dividend. You have earned tax-free dividends when you sell an asset that has grown in value, you have to pay tax on tax.
Half of the gain. So if I have a million dollar portfolio and it has grown to $2 million, and let’s assume it was just growing in value, not producing interest, not producing dividends. We’re not going to go down that path today. Just the value of it, and you sell that $2 million is sold.
The $2 million returns to your corporate account. It’s there. I’ve got $2 million. $1 million is returned.
As a return of capital to the corporation, still has to find a way out through a salary or an ineligible or eligible dividend, depending on how those dollars were earned. The other million I have to pay tax on. So I’m going to at least temporarily have to pay 50%-ish in tax on the million inside the corporation. However, the other half a million is credited to the capital dividend account. It’s just a ledger.
Jon Orr: Inside the court.
Kyle Pearce: And it’s just on, you know, basically on the books where it says, hey, this 500,000, you can now take out. You can take a capital dividend, which means at a personal level, I will get $500,000 out of this corporation and not pay any tax on it because it’s the tax-free portion of the capital gain, just like it would happen in my non-registered account.
Jon Orr: Tax free.
And I can choose to pull a hundred this year, fifty this year, two hundred this year, save the rest for another year, that kind of thing.
Kyle Pearce: Exactly. And typically people wait until, you know, there’s a significant enough capital dividend credit to make it worth it because, you know, your account’s gonna have to file paperwork for it. So there will be a cost to doing this. So if you have two grand of a capital divid account credit, that’s probably not gonna be something that you’re gonna be like all over. But if I had 500,000 in there, you would mention I could take it out a little bit at a time, but I’ll be fully honest and say, I don’t know why you would.
Jon Orr: Well
Kyle Pearce: I would take the whole thing out because now it’s out. Like we don’t want to keep it in the corporation. I want to take it out of the corporation. And imagine if I had a tax-free savings account that I could put all that in.
I don’t because it’s not that big yet. But if we could, that would be the optimal place for us to put that capital dividend.
Jon Orr: You can’t you don’t have the room. Yeah.
So I guess I’m thinking about so we own property in the States and and let’s say we sold one of the like and it’s owned by the corporation. So like let’s say we sold let’s let’s for examples like let’s say we invested a hundred grand. Forget all the other stuff that you said, and it’s like we sold and we got a gain of a hundred grand. So if we sold it, we got two hundred grand, we got a gain of a hundred grand here that came back to me. fifty percent of that, so fifty thousand dollars gets taxed.
Not at fifty percent. Just fifty percent gets taxed at whatever my corporate rate is at the time. Is that is that fair to say? Okay. Then the other
Kyle Pearce: But I’m gonna pause you though and I’m gonna say, let’s not deal with the US properties because we own them in a US structure. I would just redo that whole part. Yeah. Yeah.
Jon Orr: Well, okay, let’s pretend I didn’t say US for a second. Okay, let’s pretend I said so let’s just say I sold some property. But I have fifty so then the other fifty thousand is now in my cat like credited to the capital dividend account. Now let’s let’s say it’s like n this is where I probably sh you you said like either decide whether you want to leave it there or take it out, but in a way it’s like if I take it out tax free in that year
I would then want to start to play like if I knew that that had to come out, I would sh I should do the forward thinking ahead to say, I’m gonna take the fifty thousand dollars out and therefore I need to adjust my salary down to account for because I only need so much money, right? So it’s like, do I adjust my salary down to account for this to to keep things a little bit optimized and so I’m paying less tax this year because I got this tax free gain? Like there’s thinking there to do.
Kyle Pearce: You could definitely do that. Now, here’s the part that I would recommend and I have recommended for clients in that situation is we want to actually look ahead and we want to, to the best of our ability, look at what we anticipate your effective tax rate to be in the years moving forward. So, for example, like if we use the dramatic case like I had used, which is a half a million dollars of a capital gain, I could take that half a million dollar capital gain out as a capital dividend. I have it personally. I
Probably don’t need any income that year. However, I don’t want to drop my income down so substantially that I’m paying like zero effective tax because if in the next three years all of a sudden I’ve jumped back up and I’m in a 28% effective tax rate, like that’s not really good. But you could consider adjusting things down. So in the small business world like we are here, someone would want to at least take $40,000.
Out, right? Because you’re going to pay about the same personally as you would corporately anyway. If you’re in the general rate world, so you’re earning more than $500,000, I probably still want to take about $140 out-ish, because that’s going to put me at about an effective tax rate of around 25-26%. So again, every province a little different on that.
But we’re going to want to like be strategizing a little bit here. Now, some people are like,
Jon Orr: Mm. Right.
Kyle Pearce: I don’t even want to do the thinking and I’ve got a half a million dollars and I’m yeah, I’m I’m totally fine. And that’s a hundred percent fine as well. But there is some definitely some optimizing that’s worth considering here if and when we do realize capital gains.
Jon Orr: Give me the free money.
And this and this is this is you know, the and then when you did you did this projection for me was very eye-opening, which is basically saying, let’s look at the scenario year to year till you’re age a hundred, and then we can scan to see where that tax rate jumps and where it’s where it’s low, and then let let’s we can do some smoothing here to say that’s a good time to do that move, or this year might be a good time to do that move.
If you’re if you’re concerned about an optimization strategy across your years, but I have having that like mapped out full projection from st from where you are now to age a hundred, very eye-opening and and and that’s something that we do with every single client that we work with.
Kyle Pearce: Well, and something that’s worth mentioning is it’s it’s interesting because oftentimes the people that are so anti, say, RRSPs are like, I hear, you know, and and we talk about it too. Like, yeah, sure, you could get yourself into what we call the tax bomb situation. Those are good problems to have, but we can work around them. Like they are worth working around. And that’s just an optimization move that we want and should make.
The most people I find that are so anti-RSP in general are people that actually don’t have a tax problem yet, and they’re not on track to have a tax problem, even if they use the RSP, because they’re not saving at a high enough rate. So the reality is the people that usually have this problem are those who do have quite a bit of capital from year to year. They are investing a lot from year to year. The reality is that you are going to likely have a tax problem. That’s a good problem to have, and we can definitely work through it.
So why this matters though, and and coming back to the capital dividend account, I want to make sure this is clear is that in our in our non registered personal accounts, the same capital gain treatment is happening as it is in our corporation because the corporation has the capital dividend account. So it has that ledger to allow us to get the tax free portion of the capital gain to come out tax free to the shareholders. That is fantastic.
The one thing that we don’t have, and it brings us all the way back to the beginning of the conversation about whether if I’m only earning, I say only, like I’m earning $250,000 net operating income before I pay myself. Should I be putting money in the RSP or should I be investing that money in the corporation? Again, there is no hard, fast rule, but something important to know is when we put money in the RSP, there is no capital dividend account.
To get out the tax-free portion of a capital gain. Why that matters is because if I invest in the same, I’m going to use Bitcoin as an example because Bitcoin is only a capital gain asset, right? It’s only a capital gain asset. So therefore, it’s not going to produce interest or dividends. And if I buy this inside a Bitcoin ETF inside the RSP and I sell it,
And I had a million dollars of this asset and it grew to 2 million. I put a million in, it’s all tax deferred, it grows to 2 million. I don’t get $500,000 of tax-free capital dividend coming out of the RSP. I have to pay tax on the full two million.
We don’t want to do it all today. Like we’re going to take it out little by little, right? And year by year. And we’re going to work around that.
We’re not discounting the RSP by any means. We’re just saying this is something.
We have to recognize in terms of the difference. So in order for us to save the nine to 12% when we’re in the small business years where we’re growing our business, the RSP is going to be less flexible than say having slightly less in the corporation to invest in that same asset that’s a capital capital gain asset. It grows and then I get the capital dividend account credit. So we don’t want to go all in or all out on any one bucket here. We want to.
Try to utilize them at the right times where possible. And if worse comes to worse, we usually say, like, usually the answer lies somewhere in the middle. So doing some form of balance is always helpful. So it’s like we’re not, you know, you might do a little in the RSP one year and a little in the corporation. In the early years of the business, I recommend that we don’t get too crazy on the RSP unless you’re in a significantly high tax bracket for then.
Let’s keep more accessible to us, keep that flexibility, and then let’s create a tax problem in the corporation where suddenly we go, you know what? I want to start taking more money out of here and I’m gonna put it in the RSP. So I have diversification of where I’m going to have all of these assets stored throughout my lifetime.
Jon Orr: It’s
I think what you’re saying is you know, you’re growing growing in your corporation is a flexible wealth engine. And we need to be not afraid to invest in that engine, because we have flexibility around how to get that money out in a number of different ways. And that’s that’s the episode here, right? Is to say, How do I pay myself with when I have these scenarios with with a small business?
So we gotta start with that lifestyle number. We gotta start with like what do I need? Because that will dictate
really the choice or or a combination of the choices between salary and dividend, what do I really do there to to tr make sure that I get myself the right number to live on. but then also make sure I leave the spread inside the corporation so that I can grow that efficiently. I can grow that in terms of being flexible down the road. And and so I think that’s that’s the you know the great move, but I think have you y you kind of expressed it, having the thought partner and the thinking around what makes this move better than that.
is always a a great move. And if you’ve listened to this episode and you have no idea what that spread is or what’s sitting in those accounts, then that’s exactly what we do with you is that we’re gonna sit down, we’re gonna look at this, we’re gonna look at that w you know, what does this look like from now till age a hundred? And give you the full picture across corporate structures, personal structures, so that you know what the spread is. You know that taking a salary dividend is. Yes, the accountant can do this.
But there’s power in you understanding how these these components work. And you don’t want to be kind of relying on someone else to dictate this for you. You need to kind of, this is one of the our core beliefs is that yes, we have accountants, but we dig into the understanding. And that’s why we have the podcast is to share that understanding of what we’ve dug into back to you. So if you want us to take a look at your spread and help you think about this with a thought partner and a planning partner, then click in the link below around this this episode.
And book a call with us. We’ll be happy to help you think about this strategy from now into age a hundred.
Kyle Pearce: Awesome stuff. And if maybe you’re earning more than that $500,000 amount, keep in mind we are going to be digging in to another case study coming up here real soon so that we can go through some of this ineligible, eligible dividend scenario. And then we are also going to be handling the passive income challenge and how we can try to best optimize those scenarios when, again, you have a good problem to have where you’re seeing the grind down rule take effect. A problem.
That is worth solving.
Jon Orr: Just a reminder of the content you’re here today is for informational purposes only should not construe this information as legal tax investment or financial advice. Kyle Pierce is licensed life and accident sickness insurance agent and the president of corporate wealth management here at Canadian Well Secrets.
