Bonus Down to the Small Business Limit or Dividend?

What is the small business limit, and what rate applies above it?

A Canadian-controlled private corporation (CCPC) pays federal tax of 9% on active business income up to its business limit: $500,000 for a corporation not associated with another. Income above the limit is taxed federally at 15%. Each province or territory adds a lower rate on income up to its own limit and a higher rate on the rest. In British Columbia, for example, the total is 9% plus 2% up to the limit and 15% plus 12% above it (CRA rates; Income Tax Act, section 125).

The limit you actually have can be lower, shared or different. A case is not simple when:

• year-end is close or has just passed: a bonus counts for the year only if it was owed at year-end and is paid within 180 days after it (below);
• taxable income is below book profit (for example from loss carryforwards or capital cost allowance), because the small business rate applies only to the least of active business income, taxable income and the limit (section 125(1));
• the corporation or an associated corporation earned investment income in the prior year;
• the corporation is associated with another one, so they share one limit;
• the corporation and its associates hold a large amount of taxable capital;
• the tax year is shorter than 51 weeks;
• the corporation is in Quebec or Alberta, or in a province with its own limit;
• control of the corporation changed hands this year, which ends its tax year at that moment (see deemed year-end on a change of control), and the small business deduction needs a CCPC throughout the year (section 125(1));
• the income comes from a personal services business or a specified investment business, which generally does not get the small business rate (CRA T2 guide; see personal services business).

What to gather: year-end profit and taxable income from current books (with any loss carryforwards), last year's investment income for the corporation and every associated corporation, who owns or controls those corporations, the province, the year-end date, whether a payroll account is open, your other income for the year, and the cash the corporation must keep.

Why would a corporation bonus its profit down to the limit?

A bonus is a salary expense, so the corporation deducts it and its taxable income falls by the same amount. Income above the federal limit faces 15% federal tax, plus in most provinces the provincial higher rate, from 8% in Alberta to 15% in Newfoundland and Labrador and Prince Edward Island. Where a province sets a higher limit, part of that slice still gets the provincial lower rate (last section) (Alberta; CRA). A bonus that leaves taxable income at the limit keeps the slice above it out of the corporation and puts it on your return as employment income.

Aim for the limit and no lower: a bonus larger than the slice above it also takes income the small business rate already covers and puts it on your return. The corporation's own CPP and EI on the bonus are a further expense of the corporation (GIFI item 8622), so the bonus that brings taxable income exactly to the limit is a little less than the slice above it.

Does it make sense to take all income over the small business limit out as personal income?

Sometimes, and no single rate decides it. For the slice above the limit, compare the total tax on each path, corporate and personal together:

1. Leave it inside and pay a dividend later. The corporation pays general-rate tax when the income is earned, and you pay personal tax when the after-tax amount is paid out as a dividend (CRA Folio S3-F2-C2).
2. Pay a bonus. You pay personal tax on it this year at your marginal rate, plus the payroll costs below.

Cash left inside and invested adds investment income, which can shrink a later year's limit (next section). Treat the bonus as a calculation on year-end numbers, not a rule of thumb.

What reduces the small business limit?

The federal limit starts at $500,000 and is cut by the larger of the investment-income reduction and the taxable-capital reduction (section 125(5.1)). Association and a short year change it further.

Adjusted aggregate investment income is mainly income from property, such as interest and rent, plus net taxable capital gains on assets not used in the business (section 129(4); section 125(7)).

Two traps. Both tests look at earlier years' amounts (the taxable-capital test uses current-year capital only for a corporation that was associated last year and is not now, section 125(5.1)), so a year-end bonus cannot repair this year's limit. And without a filed Schedule 23 agreement, the Act gives each associated corporation a nil limit; if none is filed within 30 days after the CRA's written notice, the CRA allocates the limit (section 125(2) to (4)). For how the deduction works in general, see how Canadian corporations are taxed; for the capital reduction after a funding round, see SR&ED and small business limits after a large round; for investments held inside, see holding and investment corporations.

Is a bonus deductible in the year it is accrued, and how long do I have to pay it?

Yes, if it is owed at year-end, reasonable and paid within 180 days after the end of the corporation's tax year. Salary, wages or other remuneration still unpaid on the 180th day is treated as an expense of the year it is paid instead, unless it is reasonable vacation or holiday pay (section 78(4)). Only the reasonable part is deductible, so a bonus out of line with the work done may be reduced (section 67).

So a corporation with a December 31 year-end can deduct a bonus for that year and pay it in January, and you report it a year later. The accrual has to be a genuine liability at year-end, one you have an enforceable claim to (CRA IT-109R2, archived). That test looks at year-end, so the amount and the obligation to pay are normally settled before then, and a bonus first decided afterwards is unlikely to count for the year. Whether a particular accrual counts depends on the facts.

What payroll costs come with a bonus: income tax, CPP and EI?

The corporation withholds income tax, CPP and, where you are insurable, EI, using the CRA's method for lump sums such as bonuses (CRA). If it does not withhold and remit, its directors at the time are personally liable with it for the amount, and recovery must start within two years after the director last ceased to be a director (Income Tax Act, section 227.1; Canada Pension Plan, section 21.1; Employment Insurance Act, section 83). See running payroll for remitting.

CPP and EI stop at their yearly maximums, counted per employer and per calendar year of payment: pay from another employer does not use up this corporation's limits, and the limits restart in January even for a bonus the corporation deducted the year before (CRA). A bonus on top of pay from this corporation that already reached them adds no more of either, while a bonus to an owner with no other pay from it can reach the CPP maximums for you and the corporation. Some provinces add a payroll levy: Ontario's employer health tax counts a bonus as remuneration in the year it is paid or deemed to be paid, after the employer's available exemption (Ontario).

What does a bonus do for my RRSP room?

A bonus adds RRSP room; a dividend does not. Employment income counts as earned income, and dividends are not in the definition (section 146(1)). Earned income this year creates room for next year: new room is 18% of the previous year's earned income, up to the dollar limit (CRA). Next year's limit is $35,390, and about $196,612 of earned income this year creates all of it, if you have no other adjustments (CRA).

A bonus received in January is reported on that year's T4, so it counts as that year's earned income and creates room the year after. For the salary needed for room and CPP, see salary for RRSP room and CPP; to send a bonus straight to your RRSP, see paying a bonus directly to your RRSP.

Bonus or dividend for the profit above the limit?

A dividend comes out of after-tax profit, so the corporation pays its corporate tax first (the general rate on the slice above the limit, except where a higher provincial limit applies); a bonus is deducted, so it pays none on that amount.

Profit taxed at the general rate builds the corporation's general rate income pool, which backs eligible dividends. Eligible and non-eligible dividends have different gross-ups and credits, so use the type the corporation can support: it designates an eligible dividend in writing, before or when it is paid, and may not designate more than its pool (CRA: designating eligible dividends; CRA: general rate income pool). Which route leaves more after tax depends on your province, other income and that dividend type. Salary or dividends compares them in full, and tax on dividends from your corporation gives the rates by province.

Do Alberta, Quebec and provinces with a different limit change the answer?

Yes. Federal tax uses the federal limit, whatever the province's limit is. Where a province sets a higher limit, its lower rate can reach past the federal limit, so there can be two numbers to bonus toward; the province's rules decide.

Sources: CRA rates and limits, Saskatchewan, Alberta, and the CRA's Nova Scotia and Prince Edward Island changes.

Nova Scotia and Prince Edward Island both raised their limits part-way through a year. When a rate or limit changes during your tax year, the CRA has you calculate by the number of days each applies, so a year that straddles the change blends the old and new numbers (CRA Nova Scotia).

Provinces also set their own reductions. Ontario does not apply the federal passive-income reduction to its limit, though its taxable-capital reduction applies (CRA), so an Ontario corporation with high investment income can have a lower federal limit than its Ontario limit.

Quebec and Alberta have no corporate tax collection agreement with the CRA, so each corporation files that province's own return (Alberta's is the AT1), and the CRA table does not cover them (CRA; Alberta). This page does not cover Quebec's small business deduction conditions. A corporation active in several provinces must also allocate its small business income among them (CRA); see operating in more than one province.

Example

All figures are illustrative and in Canadian dollars. Taxable income is assumed equal to profit. Personal tax and payroll costs are left out unless stated.

Ontario profit over the limit, December year-end

An Ontario corporation with no investment income or associated corporations has C$650,000 of active business profit before any bonus. Its limit is C$500,000, so C$150,000 sits above it. Left inside, that slice faces 15% federal plus 11.5% Ontario, or 26.5%, which is C$39,750.

• Year 1: On December 31 the corporation records a C$150,000 bonus. Taxable income falls to C$500,000, all within the limit.
• Year 2: The bonus is paid in January, within 180 days of year-end. The corporation deducts it in Year 1. You report it on your Year 2 T4 and return, and it counts as Year 2 earned income, which creates RRSP room for Year 3. Paid after the 180th day, it would be deducted in Year 2 instead.

The comparison is the corporation's 26.5% plus dividend tax later, against your marginal rate on C$150,000 now.

Investment income cuts the limit

A corporation with no associates has C$650,000 of active business profit and had C$90,000 of investment income in the prior year. The excess over C$50,000 is C$40,000, and five times that is C$200,000, so the federal limit falls from C$500,000 to C$300,000. C$350,000 of the profit sits above the federal limit, not C$150,000. A bonus aimed at the full C$500,000 would leave C$200,000 at the federal general rate. Ontario's own limit ignores this cut, so there the provincial lower rate would still reach C$500,000.

Saskatchewan has two limits

A Saskatchewan corporation has C$650,000 of profit and no reductions. Its provincial limit is C$600,000 and its federal limit is C$500,000, so C$50,000 sits above the first and C$150,000 above the second. A C$50,000 bonus brings income to the provincial limit, but the C$100,000 between the two limits still faces the federal general rate. Whether to bonus the larger amount comes down to the same comparison as above.

Different for you?

• Your profit is near or above the limit, or you hold investments or own another company: the limit you really have after the reductions, and the bonus amount, need last year's investment income and the association facts; get corporate tax help.
• Year-end is close and the bonus must be accrued and paid within 180 days: the amount, the payment date and the payroll set-up all have to line up; get corporate tax help before year-end. With no payroll account yet, see running payroll; if a remittance deadline has passed, see late payroll remittance.
• Year-end has passed and no bonus was recorded: a bonus first decided now is unlikely to count for the year just ended; get corporate tax help before relying on it.
• Your books are behind, so year-end profit is unknown: a bonus cannot be sized without it; see catching up on overdue books and bookkeeping help.
• Your corporation is in Quebec or Alberta, or earns income in more than one province: the limit and rates come from that province's rules; get corporate tax help.
• You are choosing between salary and dividends overall: see salary or dividends and how much to pay yourself.
• You already took the money out and want to call it salary: see paying yourself a salary after the fact.
• You owe the corporation money: see shareholder loans.
• You or a co-owner is a US citizen or lives in the US: the US side of owning a Canadian corporation has its own filings and tax; see American owners of Canadian corporations and get cross-border tax help.
• Your corporation is an incorporated contractor: income from a personal services business generally does not get the small business rate, and pay to its incorporated employee deducts only if paid in the corporation's year, so the 180-day accrual does not apply (paragraph 18(1)(p)); see personal services business.