More questions to answer…These are good questions though because this stuff is pretty common.
DK wrote in the comments…
1. Incorporating – I’m guessing being able to split your income between different individuals, to take advantage of lower tax brackets? I think corporations also have a lower tax rate for the most part, although it depends?
To split income people usually fill out a form T2200. What often happens is, one spouse will own a business and the other spouse will help out with it. So you check “yes” in the second bullet point in part 9 to allow this. You don’t have to file this form, you just need it on hand in case CRA comes a knockin’.
People typically incorporate because corporations have a lower tax rate. Look at this link. If you add up the federal and provincial tax rates for income under $400,000 (the low rate), you get 16.5%, which is usually a lot less than someone’s personal tax rate. That being said, you have to keep the money in the corporation to benefit from the lower tax rate. I’ve seen people incorporate, then pay themselves all the money out of the corp, which defeats the purpose of incorporating in the first place. You just take out what you need. There are lots of other reasons for incorporating, but I find this one to be the most common.
Corporations have a low tax rate because of the small business deduction on the first $400,000 of income. Once they break this threshold they have to pay tax at the high rates. Corporations also pay tax at the high rate on investment income, but you get some of it back through RTDOH (refundable dividend tax on hand). RDTOH sucks because it’s confusing.
2. Paying div vs salary - Is it the tax credit vs expensing? I guess you have to look at the shareholder’s total income position? Do they save more on the personal side or the corporate side?
This whole deal is referred to as “integration” and it’s really messy. Pretty much, it’s better to pay a dividend below $400,000 and a bonus above $400,000. I actually had to do this analysis last week for people in BC – it sucked worse than this. But I learned a lot doing it.
Is it a tax credit vs expensing? Sort of? You want to compare the after tax proceeds the owner will receive under both situations – paying a dividend vs. a bonus. If you pay a bonus you’ll pay CPP and EHT in the corp. And then the taxpayer will pay personal tax on the bonus. If you pay a dividend you’ll pay taxes in the corp (at 16.5% because it’s under the sbd).
Dividends make it a bit tricky though, because the owner will receive a T5 for the grossed up amount of the dividend – 25% in this case. So if the corp pays a 100,000 dividend he’ll get a T5 for 125,00. And the credits/tax will be calculated on the grossed up amount.
The credits – this is very important to understand – act to offset the tax you paid in the corporation. CRA wants to make business owners indifferent as to how they receive income – dividend/bonus whateves, it’s coming from the same place so it should attract the same tax.
You can’t think of it as, “saving more on the personal side or the corporate side” because either way the owner is on the hook for his personal tax and the tax in the corp.
It’s not so much an analysis of the person’s income position. It’s an analysis of which situation is better. Personal income will be a component of that analysis.
3. Setting up a trust, other than testamentary – Another mechanism to split income? Isn’t this bordering on GAR though?
Yeah, you can set up other trusts will cool names like “inter-vivos” but I don’t know much about them. This is a lawyer question. Accountants usually deal with trusts because someone died or they’re doing a section 86 roll over. I hate section 86 roll overs. They’re way too complicated. I actually had the guy who wrote my university tax textbook explain them to me while I was at the SOA. It was jibberish. But it was a highly enjoyable conversation. Stan Laiken is by far the most entertaining and knowledgeable tax person I’ve ever met. That guy loves tax like this guy loves Halo.
A section 86 rollover works like this;
- Person A rolls over shares in a corporation to a trust. Usually for a preferred share.
- Person B buys shares of the trust – which now own the shares in the above corporation.
- Person B now effectively own’s the above corporation.
You’ll usually see this when people are doing succession planning. A parent may want to pass on his business to his kids. So he sets up a trust, rolls over his shares to the trust, and then gets his kids to buy shares of the trust. I’m pretty sure section 86 allows you to avoid the taxable gain when the parent transfers his shares.
4. Bonusing down - If a company is above the small business limit, and he wants to declare a bonus…why do this? is it to avoid the income above the limit being taxed at a higher rate (i.e. b/c it doesn’t qualify for sbd?)
Apart from getting more money, some people do this to increase their RRSP limit for the year. It’s a tax-planning thing. The bonus will increase your earned income. Your RRSP limit is based on a % of earning income (up to a point though). Therefore, by increasing your bonus, you’re increasing your RRSP limit. And that will allow you to contribute more to your RRSP, which will allow you to deduct more on your personal tax return. You pay less taxes and boom goes the dynamite.
5. Moving past NTRs – How long did you do NTRs before you thought you had learned all you could? I keep thinking that NTRs will only provide so much knowledge before I”ll be craving for something more challenging.
I did NTR’s for about 7 months, and then I did my first audit. And I didn’t know much going into the engagement. I learned a lot on the fly, which made me a stressed out mess.
Basically, there’s no real way to learn everything and be prepared.
But in hindsight if you want to learn something difficult and in a really short amount of time then that’s the best way to go about it. Just getting thrown in the deep end and often. Feeling that anxiety also ensures you’re not being stagnant.
So don’t worry, things will get far more challenging and you’ll wish you were doing NTRs again.
Now watch this. Why? Because it’s awesome.