Retained Earnings: Three Ways to Use Your Corporation's Surplus

Most incorporated owners do one of two things with surplus: leave it in the corporation or pay it out to themselves. Both are reasonable, and both can cost more tax than people expect. A third path, using a planning structure alongside the corporation, is often worth a look once surplus becomes significant.

1. Leave it invested in the corporation

Keeping money in the company defers personal tax and keeps it available for the business. The catch is what happens once it's invested:

• Investment income earned inside a Canadian-controlled private corporation is taxed at roughly 50% in Ontario. Part of that tax is refunded, but only when the corporation later pays taxable dividends.
• Once passive income passes $50,000 a year, it can start to shrink the federal small business deduction on your active business income. We explain this in the $50,000 passive income rule.

2. Take it out personally

Paying yourself more salary or dividends moves money into your hands, where you can use RRSPs, TFSAs and personal investments. But it adds a layer of personal tax now, often at top marginal rates above 50% in Ontario, before the money is ever invested.

Salary creates RRSP room and CPP benefits and is deductible to the corporation. Dividends don't create RRSP room. The mix between them is one of the most important conversations to have with your accountant each year.

3. Use a planning structure

Several structures can sit alongside your corporation and reduce the tax drag on long-term surplus, when they're set up properly and reviewed with your accountant:

• Individual Pension Plan (IPP): a corporate-funded pension that can allow larger deductible contributions than an RRSP for owners over 40 on salary.
• Retirement Compensation Arrangement (RCA): retirement funding above registered limits for higher-income owners, with a 50% refundable tax.
• Corporate-owned life insurance: permanent coverage with tax-sheltered growth that isn't counted as passive income, and a Capital Dividend Account credit at death.
• Corporate Insured Retirement Program: a leveraged concept that borrows against a corporate-owned policy in retirement. It has real risks, including borrowing costs and lender terms.

Which mix is right?

Most owners end up with a combination: some salary, some dividends, a reserve inside the company, and one or two structures for long-term surplus. The right combination depends on your age, income, family, and when you expect to sell or retire.

Not sure where you stand? That's what a 15-minute call is for. We work alongside your accountant, not instead of them, and nothing is recommended until they've reviewed the numbers.