Due to specific tax treatment, dividends from Canadian corporations can be a desirable investment in non-registered institutions. They can contribute to lowering your average tax rate thanks to this special treatment, particularly during retirement.
But because of this specific tax classification, it might be difficult to comprehend how are dividends taxed in Canada. But I will tell you everything about taxation in dividends.
Let’s dive deep into it…………………
1. How are Dividends Taxed in Canada?
There are multiple things when it comes up to taxation in Dividends in Canada. You need to understand each of them properly to get to know everything about taxation in Dividends.
So, let’s start it with why it’s important to understand the dividend tax credit…..
1.1 Why it’s Important to Understand the Dividend Tax Credit?
In terms of dividend taxation, if you’re sitting here thinking well I only have an RRSP or a TFSA and I haven’t maxed them out yet so this article isn’t really for me.
It’s essential to understand that the end goal should ultimately be to max out those accounts and essentially you’re going to have a taxable account that is earning you income and capital gains as well.
So, the dividend tax credit is an essential thing to understand and a lot of people think that it is pretty much unfair the way they do it but in reality, you’re getting a huge advantage. But first, to know how dividend taxation in terms of the grand scheme of investment taxes works and how it’s kind of the middle of the line in terms of benefits with taxes
1.2 How Dividend Taxes Stack Up Vs Interest Income & Capital Gains
So, in terms of taxation, the worst taxation you can endure is interest income. That is because it is taxed at 100 of your current income.
If you make a thousand dollars in interest income say from a bond you will be taxed your nominal tax rate on that money. So, a thousand dollars in interest income and you’re in say a 30-tax bracket. You will be charged 300 on that interest income. But if you have to say capital gains you make a thousand dollars in capital gains.
Capital gains are only taxed on 50 of your capital gain. So, let’s say we make a thousand dollars in capital gains 500 of that is taxable at our 30 tax rate which equals 150 dollars in taxes which is half the rate of interest income.
And if we move forward to dividend income, it comes in between interest income and capital gains. You will pay more taxes on dividends than you would capital gains but you will pay fewer taxes on dividends than you would interest income. In order to figure out how dividends are taxed here in Canada and how they truly are a tax-beneficial way for people to earn income we have to understand what the dividend tax credit is. One thing I do want to reiterate is that this is for dividends paid by a Canadian corporation only.
1.3 Going Over the Dividend Tax Credit
Dividends received by foreign companies such as owning U.S. stocks are subject to full taxation. And this is really going to make sense when you figure out that Canadian dividends from Canadian companies are paid with after-tax profits. So, the company says Telus say BCE say Enbridge they’re paying income tax to the Canada revenue agency before they pay you that dividend. The government is giving you a dividend tax credit in order to avoid double taxation of that money.
How do they do?
This is the gross-up of your dividend income as they call it so this is essentially what the CRA does to emulate the income that you would have been paid had the corporation not paid income tax on that money.
1.4 The Dividend Gross-Up Explained
Let’s look at what dividend gross-up is and I really need you to bear with me during this portion because it is going to seem like you are being treated extremely unfairly when it comes to the taxation of dividends here in Canada when in reality it is a huge benefit.
So, for right now and it’s very important that you understand that the time you’re reading this article might not be the same in terms of dividend gross-up or even any of the tax numbers calculated. It is absolutely imperative that you check the recent tax rates or you get a qualified accountant to do your taxes and you’re simply reading this article just to learn.
The dividend gross-up is currently 38 on eligible dividends and 15 on non-eligible dividends. The difference between eligible and non-eligible dividends the only thing you really need to know is that the company must tell you what a dividend is. You do not need to search for this information yourself or figure it out yourself, and secondly eligible and non-eligible just means that the corporation paid fewer taxes on the non-eligible dividends.
As such they are qualified for less of a dividend gross-up so eligible dividends are a 38 gross-up and not eligible are 15 dividend gross-up
1.5 Calculating Dividend Gross-Up
Let’s look at a situation where we have on one end a thousand dollars in eligible dividends and on the other hand we have a thousand dollars in non-eligible dividends.
We’re going to take that thousand dollars in eligible dividends and we’re going to times it by 1.38 to get 1380. For the non-eligible dividend situation, we’re going to take that thousand dollars and we’re going to times it by 1.15 to get eleven hundred and fifty dollars to get the total dividend gross-up of the non-eligible dividends.
Now this is the dividend income that you’re going to be taxed on and this is where so many people get confused they’re sitting there thinking I’ve made a thousand dollars in dividend income but I’m getting taxed on thirteen hundred and eighty dollars how is this even fair and again I can’t reiterate enough it is going to make sense as I walk through this so keep reading.
1.6 Calculating Dividend Tax Credit
We now need to calculate your dividend tax credit and for the purposes of this article, I’m going to stick to federal dividend tax credits only because we have a wide audience here in Canada and it would not be great to mislead anybody on provincial dividend tax credits.
If you want to learn your provincial dividend tax credit just look up the current tax rates of your province. The calculation will be much the same. as we are going to do shows.
It’s just on a provincial level, not a federal level. As of right now the dividend tax credit on eligible dividends federally is 15.0198 percent and on non-eligible dividends, it is 9.031 percent. But again to make this really simple to calculate the dividend tax credit we’re going to speak on an eligible dividend only as the vast majority of the dividends you are likely to receive will be eligible for dividend tax credit purposes.
We’re going to take our thirteen hundred and eighty dollars and we’re going to grab 15.0198 percent of that. That is the federal dividend tax credit on eligible dividends right now. This is going to give you a federal dividend tax credit of $207.27. Overall we’re going to figure out our dividend taxation on the thousand dollars in eligible dividends. We’re then going to subtract our dividend tax credit and that is going to give us our total taxes paid on our dividend income at a federal level.
2. Know More About How Dividend Tax Credit
If you aren’t really that comfortable with the dividend tax credit and that is that you are still extremely confused right now. Let’s put all that to bed with an in-depth example.
We’re going to look at a combination of eligible and non-eligible dividends and a particular tax bracket to figure out how much income tax you are going to be paying on your dividends and how this dividend tax bracket is truly beneficial even though it looks poor on the surface.
Let’s get the example started let’s say we have John and he has received a total of a thousand dollars in dividends. 800 of them are eligible and 200 of them are non-eligible. Let’s assume that John is in a high tax bracket with his nominal tax being 30 percent.
First, let’s gross up the dividends. We have 800 in eligible dividends and if you remember the dividend gross-up for eligible dividends is 38 percent. We’re going to take 800 and times it by 1.38 to get our $1104 in eligible dividends grossed up.
Let’s go to the non-eligible and if you remember the non-eligible gross-up percentage is 15 percent right now.
We’re going to take that 200 times by 1.15 to come up with $230 in non-eligible grossed-up dividends. Now adding both of those together to come up with our total taxable dividend income of $1334. With john being in the highest tax bracket he will pay 30 percent on this grossed-up dividend income or $400.20.
Now, this is where a lot of people get confused again. We have a thousand dollars in dividend income John is in the 30 percent tax bracket yet he’s paying $400 or essentially 40 percent on his dividends paid. But we haven’t applied for the dividend tax credit yet, so if we head back we have to figure out our dividend tax credit.
The dividend tax credit on eligible dividends at the federal level is 15.0198 percent as we discussed before. We take 15.019 percent of 1104 dollars which is his grossed-up eligible dividend income and we come out with a tax credit of $165.81. We are then going to take 9.031 percent which is the non-eligible federal dividend tax credit and we’re going to take that from 230 which is his non-eligible grossed-up dividend income and we’re going to get 20 dollars 77 cents.
Now we’re going to take both these 165 81 cents and $20.77 we’re going to add them together to get a total dividend tax credit of 186 dollars and 58 cents. Another tripping point here another uh area where a lot of people get confused is they take this 186 dollars in credit and apply it to their total taxable income. Their total grossed-up income but this doesn’t work this way.
This dividend tax credit comes off of your taxable income so if we take from the example John had 400 dollars and 20 cents in total taxable income. We’re going to subtract the 186 dollars and 58 cents from that to come out to a total amount of taxes due of 213 dollars and 62 cents.
Now it’s starting to look a lot more attractive right? We have John in a 30 percent tax bracket who is paying 213 dollars in taxes on his dividends. That’s only a 21-tax rate showing you the benefit of owning Canadian dividend stocks when applying this tax rate. Initially, the gross-up looks really bad but after we come to the bottom end and figure out the actual amount of taxes we’re paying it is extremely beneficial. It’s going to get even more beneficial as I’m going to show you next when you are in a lower tax bracket. Now you probably have a lot clearer picture of how the dividend tax credit here in Canada works.
This was all about “how are dividends taxed in Canada? “. Dividends are really capable and can be a good investment. If you want to know about the right Canadian software for tax then check this out.
Frequently Asked Questions
Some of the most asked questions from the dividends are listed below:-
Q1. Are dividends taxed differently than the normal income tax?
Yes, the dividends are taxed differently than the normal income tax.
Q2. How much tax do you pay on dividend income?
The tax rate lies from 10 percent to 37 percent for dividend income.
Q3. What is the dividend tax rate in Canada?
It is 38 percent for eligible and 15 percent for non-eligible.
Q4. Are dividends taxed higher than capital gains in Canada?
Yes, the capital gains are taxed lower than the capital gains in Canada.
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