One of the ways you can build an investment income stream is through the use of dividend stocks. When you own dividend stocks, you receive an extra payout from the company. This payment is a portion of the company’s profits, and is above and beyond capital appreciation. As long as you own shares in the company, you receive dividends.
Realize, though, that dividends are considered income, and the CRA wants a cut of this income. The good news is that you can use the dividend tax credit to reduce your tax liability for this type of income. The dividend amount that you receive is “grossed up” from its payout in order to more closely represent the “original” pre-tax amount (since your dividends are paid by the company with after-tax dollars, so your paying taxes on top of it amounts to double taxation of the same money).
Eligible Dividends vs. Non-Eligible Dividends
First, you have to determine if your dividends are eligible for the full dividend tax credit. For the most part, public Canadian corporations are considered eligible, as are foreign companies that operate in Canada. Non-eligible dividends are generated by companies that are not Canadian, and do not operate in Canada. Additionally, if the company’s income enjoyed the tax at the small business rate, the dividends might be considered non-eligible.
Non-eligible dividends are still “grossed up”, but they do not see as high an amount, and therefore the dividend tax credit isn’t as much for non-eligible dividends.
Calculating the Dividend Tax Credit
The gross up amount changes according to the CRA’s assessment of the situation. For the 2012 tax year, the gross up amount was 38% and the credit was then calculated at 20.73% for eligible dividends. For non-eligible dividends, the gross up amount was 25% and the credit amount was 16.67%.
If you want to calculate the dividend tax credit for your income, here is the process you follow, assuming your dividend income in 2012 was $5,000, and you are in the 15% tax bracket:
- Multiply $5,000 by 0.38 (38%) to get a gross up amount of $1,900
- Add that to your original dividend income for a total of $6,900
- Figure the tax on that amount, remembering that you are in the 15% tax bracket by multiplying the $6,900 by 0.15 for a total tax on the dividend of $1,035
- Now, figure the tax credit amount on the original $5,000 you received by multiplying that amount by 0.2073 for a total credit of $1,036.50
As you can see, the credit is $1.50 more than the tax you would owe on the grossed up amount. As a result, you don’t owe taxes on your eligible dividend earnings. Realize, though, that this is a non-refundable credit, so you don’t get the difference applied to your tax bill in other places, nor do you get the money added to your refund.
If you follow the same process with non-eligible dividends, though, the total that you figure the tax on ends up being $6,250, for a tax bill of $937.50 (15% bracket). The credit is only 16.67%, so the amount of the credit on the $5,000 in income is $833.50. When you subtract that from the tax bill of $937.50, you end up owing a tax of $104 on your non-eligible dividends.
If you need help figuring your dividend tax credit, you can use tax prep software, or consult a professional.