Should You Opt for a Year-End Bonus or Dividends from Your Company’s Profits? 

As the year draws to a close, business proprietors face crucial choices to minimize their annual business taxes. One such decision revolves around the distribution of bonuses. Let’s delve into the best course of action for you. 

Bonuses vs. Dividends: 

In Ontario, a Canadian controlled private corporation’s business profit, up to $500,000, is subject to a tax rate of 15.5%. However, any profit exceeding this amount is taxed at a steeper rate of 26.5%. To circumvent this elevated tax rate, you might contemplate declaring a bonus to bring your company’s profits down to a maximum of $500,000. As long as this bonus is declared by the fiscal year’s end, it qualifies as a tax deduction, even if it remains unpaid. When you eventually receive this bonus, it will be taxed at your personal marginal tax rate, which stood at 53.5% in Ontario as of 2016. 

At a glance, opting for a bonus to sidestep the 26.5% corporate tax might seem imprudent, especially when the personal tax on bonuses is a heftier 53.5%. 

Considering Dividends: 

An alternative approach would be to retain profits within your corporation and later distribute them as dividends when you personally require the funds. In this scenario, your company would pay a tax of 26.5% on its profits. Later, when you withdraw a dividend, you’d be taxed at a rate of 38% on that dividend. Cumulatively, this amounts to a 54.4% tax, which is 1% more than what you’d pay with a bonus. 

You might now be leaning towards awarding yourself a bonus rather than a dividend, given the slightly lower tax implication. While this reasoning is sound, it overlooks the potential for your company to amplify its profits by reinvesting rather than disbursing a bonus. For instance, if your corporation can achieve a 15% return on its investments, it would be more judicious to retain profits exceeding $500,000 instead of paying out a bonus. 

Key Takeaway: 

The decision between a bonus and a dividend, for business profits surpassing $500,000, hinges on your company’s potential return on investments. If the returns are meager, it’s advisable to grant yourself a bonus. Conversely, if the returns are substantial, it’s wiser for the company to reinvest its profits and consider a dividend payout in the foreseeable future.