Disclaimer: this is specific to Ontario residents and may apply differently to residents of other provinces
By reading the title you may have jumped to the conclusion that there must be some kind of catch and there is no possible “legitimate” way of earning money without giving some back to the dreaded tax man.
However, there is no catch. You do not have to move to an island in the south deemed to be a tax haven, nor do you have to break the law!
Many of us have already heard of it, yet we may not be too familiar with the concept. It goes by the name of the dividend tax credit.
Assuming your dividends come from publicly traded Canadian corporations deemed to be paying “eligible dividends” (like Royal Bank for example), the income received through dividends is taxed through a gross up and non-refundable tax credit method. To balance this out you then receive a tax credit equivalent to 15.02% from the federal Government and 6.40% from the Ontario Provincial Government.
Let’s see how this would play out through an example.
Tim is a 50 year old Ontario resident and has just decided to take an early retirement. He has been self-employed his whole life and has put away a sizeable amount of his earnings into a non-registered portfolio of eligible dividend paying Canadian stocks on which he earns $49,280 of dividends in 2014. This is Tim’s only source of income in 2014.
At the end of the year Tim’s dividend income of $49,280 would be grossed up by 38% which would increase his taxable earnings to $68,006.40. In Ontario, $68,006.40 in income would generate Provincial taxes payable of 4,089.33. On this same amount of taxable income, taxes payable for the Federal government would be of $10,214.
The tax credits applicable to these dividends would then be added based on his grossed up dividend income of $68,006.40. The Provincial tax credit of 6.40% and the Federal tax credit of 15.02% would equal to $4,352.41 and $10,214.56 respectively.
When the Provincial non-refundable tax credits of $4,352.41 are applied to Provincial taxes payable of $4,089.33 we get $0.00 net Provincial taxes payable. When the Federal non-refundable tax credits of $10,214.56 are applied to Federal taxes payable of $10,214.00 we get $0.00 net Federal taxes payable.
In the end, not a dime of taxes will have left our friend Tim’s pocket as the tax credits will have completely eliminated any taxes payable!
Based on 2014 tax rates, you would have to earn income of $61,582 to end up with net earnings of $49,280. Thanks to dividend tax credits you can net a much larger amount while keeping more of that money in your pocket, away from the tax man!