The Financial Post has just published (in Thursday’s paper and online) my article headlined “You can earn $50K in tax-free dividends but there’s a catch: You can’t have a job.”
Can’t have a job, indeed, or a large pension or any other source of significant alternative income.
The article is based on a BMO Financial Group report (May 2016) entitled Eligible Dividend Income. It shows that at least eight provinces or territories make it possible to receive $51,474 a year in “tax-free” eligible dividend income, provided there are no other major sources of income, and notwithstanding any provincial health levies.
These include Alberta, British Columbia, New Brunswick, Ontario, Saskatchewan, the Northwest Territories, Nunavut and Yukon. It’s only $45,309 in Prince Edward Island, $35,835 in Quebec, $30,509 in Nova Scotia, $24,271 in Manitoba and just $18,679 in Newfoundland and Labrador.
BMO won’t update for 2017 until all 2017 provincial budgets are released. When it first began publishing the document for the 2012 tax year, the maximum amount of tax-free income on eligible dividends was $47,888 in Ontario and eight other provinces. The amount rose to $48,844 in 2013 and to $49,284 in 2014.
Dividend Tax Credit, Basic Personal Amount are keys
This low-tax phenomenon happens through a combination of the Basic Personal Amounts (which in 2016 makes the first $11,474 tax-free federally) and the 15.02% federal dividend tax credit on eligible Canadian dividends: once you “gross up” your eligible dividend income by 38% (required when you file your annual taxes), the non-refundable dividend tax credit kicks in, reducing taxes owing. (Your T-5 slip will indicate if the dividend is eligible or non-eligible). There are also provincial dividend tax credits: in Ontario since 2014 it has been 10% of the grossed-up dividend.
to really benefit from all this – even assuming no other large sources of income – you really have to be in the lower tax brackets. According to this site at TaxTips.ca, the tax rate (combined federal/Ontario) on eligible Canadian dividends in 2016 was actually minus 6.86% on the first $41,536 of such income. Between $41,536 and $45,282 the tax rate is minus 1.2%. John Waters, Vice-President, Director of Tax Consulting Services for BMO Wealth Management, says that merely shows the power of the dividend tax credit at lower tax rates exceeds the lowest marginal tax rates.
Those tax rates are much less than the capital gains rate of 10.03% and 12.08% in those first two brackets. Between $45,282 and $73,145 the tax rate on eligible Canadian dividends is still a modest 6.39% (compare to 14.83% for capital gains in that bracket, and a whopping 29.65% for interest or other income in that bracket.) From there, the combined tax rate on eligible dividends steadily rises, reaching as high as 39.34% for those making $220,000 or more in Ontario.
Investors dodged bullet in budget but tax pros apprehensive on what may come next
The piece closes with a mention of the recent federal budget and what investors might expect from the Liberal government in the next couple of years of its term. This is explored fully in my latest Motley Fool blog linked here, and which ran on Monday: Business owners, investors and seniors dodge bullet in recent budget.