Key Insights into Year-End Compensation Planning

Key Insights into Year-End Compensation Planning

As we approach the year-end, it's crucial to revisit your compensation strategies. Whether you're a business owner or a corporate professional, understanding the financial implications of salary and dividends can make a significant difference.

Salary as Compensation: If a corporation pays business income to the owner as salary or bonus, it can claim an income tax deduction, reducing its taxable income. The business owner then includes the salary in their taxable income, paying tax at personal graduated tax rates.

Dividends as Compensation: Alternatively, a corporation can pay tax on its corporate income in the year earned and distribute its after-tax corporate income to the owner as dividends in the current or future years. The owner pays a lower tax rate on dividends due to the dividend tax credit.

Let's consider an example: Marlon, an incorporated physician in Ontario, whose corporation earns $100,000 of taxable income in 2023. If the corporation qualifies for the small business rate of 12.2%, it would pay $12,200 in corporate income tax. The remaining amount can be distributed as non-eligible dividends; if Marlon is in the top Ontario tax bracket, he would pay approximately $41,920 on this dividend. The effective combined tax rate would be 54.12%, slightly higher than the top Ontario personal tax rate of 53.53% on salary income.

However, it's essential to note the tax deferral advantage of leaving funds in a corporation. The deferral advantage is the difference between the top rate (53.53%) and the small business rate (12.2%), or 41.33%.

As 2023 comes to a close, we encourage business owners to review their compensation plans. It's not just about the immediate tax implications, but also the long-term financial impact. Reach out to us at AMACC for tailored advice on your compensation planning.

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