Dividends and Determining Child & Spousal Support – Part 1
For anyone who may be paying or receiving child or spousal support, if the spouse paying support receives part or all of their income as dividends, it is important to understand how support payments are calculated. This can be a complicated process, so this blog will be divided into two parts. Part 1 will deal with dividends, grossing up dividends, and dividend tax credits. Part two will explain how much of those dividends will be paid as child or spousal support.
This blog is a simplification and does not represent a complete overview of dividends and income tax. If you want to know more, please seek professional accounting and legal advice.
Salaries are paid by a company to employees before tax is calculated. Dividends are paid out to shareholders from a company’s after-tax profits. So when dividend income is placed on a tax return, the company has already paid tax on that money. However, the Canada Revenue Agency (the “CRA”) wants to estimate how much money an individual would have received as a salary, so the dividend will be grossed up by 38% to reflect the amount of the company’s pre-tax profit was needed to provide a shareholder with the dividend.
For example, Widgets Ltd. has a pre-tax profit of $1,000, and Kim is the sole shareholder. Widget Ltd. could pay Kim a salary of $1,000 and have no profits to pay tax on. Kim would then have to pay income tax on the $1,000. However, Widget Ltd. instead decides to pay corporate tax on the profits and is left with $724.64. The company then pays Kim a dividend of $724.64. When Kim files her income tax, she will have to gross up her dividend by 38% ($724.64 x 1.38 = $1,000).
Now at first look, it may appear that this is unfair to Kim. She now has to pay income tax on more money that she received, but this is where the dividend tax credit (the “DTC”) comes in. The DTC is designed to prevent the CRA from double dipping. It gives the recipient credit for the tax already paid by the company. For 2017, the federal DTC was 15.0198% and the British Columbia DTC was 10%, for a combined DTC of 25.0198%. The DTC drastically lowers the tax rate on dividends.
Kim’s taxable dividend is $1,000. She will get a DTC of ($1,000 x 25.0198%) = $250.20. Kim has $40,000 in employment income, so the marginal tax rate is 22.7%. The income tax she will pay on her dividend the taxable dividend multiplied by the marginal tax rate, less her DTC.
($1,000 x 22.7%) – $250.20 = -$23.20
Kim’s income tax on her dividend is negative (-$23.20 ÷ $724.64 = -3.2%), and while she will not receive a cheque for the DTC (it is non-refundable), it can be used to offset other taxes.
The theory behind grossing up dividends and providing the DTC that an individual should pay the same amount of tax, regardless of whether the money was earned directly (salary) or indirectly (dividend). However, the way in which money is earned and how dividends are paid can significantly affect child or spousal support (see Part 2).
If you have questions about incorporation, child or spousal support, or any other legal matter, please contact Heath Law LLP at 250-753-2202.