In a previous post I briefly described the difference between non-eligible dividends and eligible dividends. This is an important topic to understand fully before we discuss the new legislation that is affecting access to the small business deduction (SBD).
There are essentially two types of income that a corporation can earn:
- Active income from the active business operations of the corporation
- Passive income from passive assets such as real estate, investments, ect.
When your corporation or any associated corporations earn passive income, any dollar earned above and beyond a $50,000 threshold will start to “grind down” your access to the SBD.
For every passive $1 that you earn, $5 will be subtracted from your SBD limit.
For example, let’s say you have an investment portfolio of $1,000,000 in an associated company of your operating company. You are earning 7% interest within that portfolio and at the end of the year you have earned passive income of $70,000.
- You have made $20,000 over the $50,000 limit.
- $20,000X5 = $100,000
- $500,000(Your SBD limit) – $100,000 = $400,000
- New SBD limit = $400,000
Let’s use this example and assume that your operating company earns a before tax profit of $450,000.
The first $400,000 will be taxed at the SBD (11% in AB currently)
- Taxes payable of $44,000
- LRIP increased by $356,000
The next $50,000 will be taxed at the General Rate (27% in AB currently)
- Taxes payable of $13,500
- GRIP increased by $36,500
If you’re not certain about what the LRIP and GRIP are please read back up on dividends in this post.
From this you can see you have $356,000 that you can pay out as non-eligible dividends and $36,500 you can pay out as eligible dividends.
As we know eligible dividends have a much more preferential tax credit than non-eligible dividends and you will be able to take out more dividends and pay less tax using your “eligible dividend pool”.
As you can see from this example, these taxes paid are not “lost” forever. They are utilized when you pay out eligible dividends. However, if your intention is not to pay out profits in dividends than from this grind down you have significantly less capital to reinvest back into your business
These rules are much more complicated than I’ve illustrated here, but this gives you a good baseline to understand the impacts this will have on your business. There are also investment strategies you can utilize that will not impact your access to the SBD, you can read about them here.
I will encourage you to schedule a free 30-minute strategy session with me.
What this session will highlight is:
- If you have unforeseen liabilities threatening your future
- How you can be more efficient with your finances and save on taxes
- How you can receive maximum after-tax value from your company if/when you sell
- How you can pass down your business to your family without sacrificing your goals
- If your planning has something missing from it
So please schedule a session and I look forward to exploring how we can help you.