Mindset: Tax as a Design Element, Not an Afterthought
For incorporated owners, tax isn't something to minimize after the fact—it's a design element to consider from the start. The most effective strategies think about income types, timing, and structures upfront, coordinating across corporate, personal, and insurance accounts.
This "dynasty-first" mindset means asking: How do we structure income to minimize lifetime tax across decades? How do corporate tax rules (SBD, RDTOH, GRIP, CDA) interact with personal tax planning? How do we design structures that work for this generation and the next?
Mechanics: How Tax Optimization Works
Income Types and Their Tax Treatment
Different income types are taxed differently, both at the corporate and personal level:
- Capital gains: 50% inclusion rate at personal level; can be more tax-efficient than dividends in some situations
- Eligible dividends: Benefit from dividend tax credit; may be more efficient than salary in some cases
- Non-eligible dividends: Higher tax rate than eligible dividends; relevant for small business deduction (SBD) companies
- Interest income: Fully taxable; generally the least efficient income type
- Salary: Deductible at corporate level; creates RRSP room; may be useful for income splitting
Corporate Tax Accounts and Mechanisms
Several corporate tax mechanisms affect optimization:
- Small Business Deduction (SBD): Lower tax rate on first $500,000 of active business income (varies by province)
- RDTOH (Refundable Dividend Tax on Hand): Refundable tax on investment income; can be recovered when dividends are paid
- GRIP (General Rate Income Pool): Tracks income eligible for enhanced dividend tax credit
- CDA (Capital Dividend Account): Tax-free account for capital gains and life insurance proceeds
Tax-Sheltering Tools
Various tools can defer or reduce tax:
- Corporate-class funds: Allow switching between funds without triggering capital gains
- Permanent life insurance: Tax-sheltered cash value growth; tax-free death benefit
- RRSPs and TFSAs: Tax-deferred or tax-free growth in personal accounts
- Estate freezes and trusts: Can shift future growth to next generation at lower tax rates
How to Apply: Owner Playbook
Here's a practical approach to tax optimization:
- Understand your current situation: Review your corporate tax returns with your CPA. Identify what income types you're earning, what tax accounts you have (RDTOH, GRIP, CDA), and how your corporate and personal tax situations interact.
- Work with your CPA: Tax optimization requires professional tax advice. Your CPA can help identify opportunities, model different scenarios, and ensure compliance. Coordinate with them on any strategies you're considering.
- Consider income type optimization: Are you earning the most tax-efficient income types? For example:
- Corporate investments: Favor capital gains over interest income where possible
- Corporate-class funds: Use for tax-efficient switching between investment strategies
- Dividend vs. salary: Coordinate with your CPA to optimize the mix
- Coordinate corporate and personal: How do corporate tax accounts (RDTOH, GRIP, CDA) interact with your personal tax situation? When should you pay dividends? How do RRSP contributions affect your overall tax picture?
- Think long-term: Consider how today's decisions affect tax over decades. What structures will minimize lifetime tax, not just this year's tax? How do estate planning goals affect tax optimization?
- Review regularly: Tax rules change, your situation evolves, and optimization opportunities shift. Review your tax strategy annually with your CPA.
Worked Example
Consider an incorporated owner with $100,000 of corporate investment income:
Scenario A (Interest income): Earns $100,000 in interest. Corporation pays approximately $50,000 in tax (50% rate on investment income). Remaining $50,000 paid as dividend, personal tax of approximately $20,000. Total tax: $70,000. After-tax: $30,000.
Scenario B (Capital gains): Earns $100,000 in capital gains. Corporation pays approximately $25,000 in tax (25% rate on capital gains). Remaining $75,000 paid as dividend, personal tax of approximately $30,000. Total tax: $55,000. After-tax: $45,000.
By choosing capital gains over interest income, this owner saves $15,000 in tax on a single $100,000 investment return. Over decades, these differences compound significantly.
Decision Checklist
Consider tax optimization if:
- You're earning investment income in your corporation but haven't optimized for income types (capital gains vs. interest vs. dividends)
- You're not sure how corporate tax accounts (RDTOH, GRIP, CDA) work or how to use them effectively
- Your corporate and personal tax strategies feel disconnected
- You're paying significant tax but haven't explored tax-sheltering tools (corporate-class funds, insurance, etc.)
- You want to understand how different income types affect your lifetime tax burden
- You're thinking about estate planning and how tax optimization affects wealth transfer to the next generation
Important Notes
This is educational content only. Tax optimization requires professional advice from your CPA. Tax rules are complex and change frequently. What works for one owner may not work for another. Always coordinate tax strategies with your accountant, notary, and lawyer.
Compliance is non-negotiable. All strategies must comply with Canadian tax law. Aggressive tax avoidance schemes can result in penalties, interest, and legal consequences. Work with qualified professionals to ensure compliance.