Everybody Pays

National Post

2010-03-02


It's 2010. Do You Know What Your Taxes Are?

If your business is incorporated, it's important to understand how income earned inside your business is taxed. The first step is to determine what type of income is being earned. Is it "active business income" from, for example, making something, selling something or consulting? Or is it passive income from investing and earning interest, dividends or capital gains? The difference is important when it comes to handling your annual tax returns.

The key issue here is whether or not your corporation earns active business income. Active business income earned by a Canadian-controlled private corporation is taxed at favorable rates owing to the small business deduction (SBD), both federally and provincially. The federal rate on the first $500,000 of active business income is 11%, while the provincial rate varies from a high of 8% in Quebec to 1% in Manitoba (which plans to reduce its rate to zero in December.)

There is, however, a threshold at which the small business deduction is capped and at which the general active business income rate begin to apply. Last year's federal budget increased the federal small business deduction income threshold to $500,000 from $400,000, however, not all provinces have followed suit. For example, the deduction in Manitoba and Nova Scotia for 2010 is still stuck at $400,000. This results in what is often referred to as a "median rate" for active business income between $400,000 and $500,000.

Let's take a look at Nova Scotia's 2010 rate as an example. Its rate for the first $400,000 of active business income is 5%, which jumps up to 16% on income more than $400,000. Combining this with the federal small business rate of 11%, which jumps to 18% above $500,000, we end up with three combined tax rates: the first $400,000 is taxed at 16%, income between $400,000 and $500,000 is taxed at 27% (the "median rate") and income over $500,000 is taxed at 34%.

Finally, investment income earned inside your corporation is most heavily taxed as it's not eligible for the small business deduction. It faces combined federal and provincial tax rates ranging from a low of 44.7% in Alberta to a high of 50.7% in Nova Scotia and Prince Edward Island.

Included in these rates, however, is a 26.7% federal refundable tax that is ultimately refunded to the corporation when it pays out either eligible or non-eligible dividends to its shareholders. The dividend refund is generally 33% of the amount paid out.