Take Canadian small business income as pay or as dividend?

[danjonwig]

I and my wife are both US persons (she is a citizen, I am a green card holder). At the beginning of 2011, we moved to Canada from the US. I have a day job, but do consulting work on the side, through a provincially incorporated corp, owned entirely by us (50/50). My wife did not have a job in 2011, save doing some work for the consulting company for which we pay her a salary.

We are now trying to withdraw the rest of the cash from the corp (cheaper this year since she will start a full time job in January). We have two ways to do this: I take a 'bonus' (regular income = high tax, given category and my bracket), or we pay her a dividend (lower tax as a dividend and because her bracket is much lower). We have set this up with the help of someone who is an expert in Canadian taxes, but not US. Our question is, which of the two methods I have described here will be lower tax?

I worry that a dividend from a 'foreign' (Canadian) corp may not be considered foreign by US since we own it, and definitely not foreign to Canada - thus, double taxation?

[nelsona]

JGCA will proabaly answer your question, but,. since you ahve moved, have determined what your deemed disposition of your private corp shares will be?

This occurs at the moment you moved.

[danjonwig]

Sorry, missed this detail - the corp was formed after we moved, the consulting wasn't allowed at my old job. We formed-up in June 2011, after moving at the end of December 2010.

I very much appreciate the quick reply.

[JGCA]

In Canada

Taking out dividends is the best tax scenario but can you only pay dividends to wife and not you as you said, if yes then she has to own a seperate class of share to declare dividens on and not to your class.


IN US

Since Canada has a dividend tax credit US does not and the dividends paid to you in Canada will be taxed as qualifying dividends in the US. If wife pays little tax on dividends in Canada she will owe more in the US on this. Best stratergy is to take out the income as a salary this way it may qualify for the foreign earned income exclusion in US or if it does not in the first year at least the foreign tax credit will apply since its salary.

As a US citizen and green card holder you have to file discloure statements on the foreign corp you hold in Canada the IRS annually it is only a reporting requirement not a tax return of the corp.

[nelsona]

JG, while we are on the subject is there any way to define "qualified" dividends for non-US stock?

I've always assumed that unless you can specifically meet all the criteria to make a dividend "qualified", then it had to be non-qulaified. This is especially difficult for privately-owned companies, no?

[JGCA]

Nelsona you are correct I meant to say that the div from a CND corp qualify in Canada for the tax credit but will not be qualified in the US for any such credit and will be taxed as ordinary income in the US.

SInce the US has no such dividend tax credit available as we do in Canada they since 2002 have teh qualified and non qualified dividend income tax rates which is due tro be phased out by the end of 2012.

So in our case your CND dividend do not qualify for the long term cap gain tax rate of 5 to 15% but will be taxed as ordinary income.

IRS only gives the qualified tax rate to shares held at least 60 days for common shares, 90 days for pfd shrs of US companies that the IRS says that they qualify and to certain foreign corps but a CCPC does not meet their criteria for qualification.

[nelsona]

"a CCPC does not meet their criteria for qualification."

Thanks.

So,it begs the question of the poster: why on earth would 2 non-residents of canada start a corporation in canada if they were neither resident nor active there?

And I guess it never qualified as a CPCC since none of the owners wer eCdn residents.


Somethings sounds awry....

[JGCA]

I don't know if they are a CCPC they said they formed it in June 2011 and left the US in Dec 10 so they may qualify since the test is to be controlled by CND residents at the time it was formed and throghout the taxation year but I suspect given the fact that they want dividends their CND accountant is deeming it a CCPC to be taxed at say 16% in the corp vs 31%.

You are right a CCPC would not qualify in the US for paying out qualified dividends.

[nelsona]

" so they may qualify since the test is to be controlled by CND residents at the time it was formed and throghout the taxation year "

They were NEVER residents when it was formed NOR for the entire year.

Can't be a CCPC in my opinion.

[danjonwig]

We really very much appreciate the lengthy discussion, but I'm getting a bit lost. Some clarifications of the situation:

- my wife and I are now (as of Jan. 2011) residents of Canada, the corp was created only after we became so. I'm a little wary of declaring that fact to the IRS, since it may prejudice my right to keep my GC, but I'd rather give it up than pay big tax. We are both still US persons.

- I cannot pay any more salary to my wife out of the corp, any salary coming out would have to be to me, and I am already in the top bracket in Canada.

- we are setup with different classes of shares (had excellent help getting this setup, just non-expert wrt US taxes). The goal of the corp was to minimize Canadian tax burden by shifting my income to my wife as salary + dividends. It may be turning out that is does not help much for US, but for Canada this minimized our exposure.

This discussn board has been quite helpful (thank you both for your length and thoughtful replies).

[nelsona]

Ah, I see. The move was TO canada. Missed that. Sorry. That makes more sense.

I would not worry about the "more tax" issue. The problem is almost always the reporting burden, not the tax.

[danjonwig]

Thank you Nelsona.

"So in our case your CND dividend do not qualify for the long term cap gain tax rate of 5 to 15% but will be taxed as ordinary income. "

Does the tax paid on this and all "ordinary income" qualify for any kind of foreign credit? What I'm trying to surmise is, if we pay this out as a dividend, does this dividend simply get added-on to our income in the US, with an associated tax bill, which is then credited by tax we pay in Canada? Even with the preferred CCPC rate in Canada, the high rate we pay on the rest of our income should help offset the difference between the dividend rate and this higher rate, no?

[JGCA]

The dividend income in Canada will be taxed at normal rates but there is a dividend tax credit built into teh system taht will drastically lower teh tax rate. Depending on province of residence as of Dec 31st of each year you could earn up to $ 20K or more a year tax free if you have very litle other income as seems to be the case of your wife.

In US you will be taxed on the dividend from Canada at normal tax rate. In Canada you will get a tax credit for teh US tax paid normally but in this case the dividend say costs 10% tax in the US and no tax is payable in Canada since your wife had litle income teh tax credit wiped it out the 10% tax you paid in US is of no benefit to her. That is why I suggested wages this way at least the corp got the deduction saved 16% and its earned income that could be excluded from US tax under certain conditions.

[nelsona]

I'm wondering if it really matters how she is paid/taxed in canada, since they will be filing jointly in US, the foreign tax credit will also be filed jointly.

There may be sufficient Cdn tax paid by the other spouse to wipe out any US tax for the couple. As we know, generally, there is way more Cdn tax paid than is needed on form 1116.

So reducing Cdn tax as much as one can is probably still the best approach.

"In Canada you will get a tax credit for teh US tax paid"

Canada will NOT give credit for any of the US tax, since they the dividend is Cdn-sourced. US taxapyers in canada only get tax credit on their Cdn return for US-sourced dividends.

What I'm thinking is that there probably will be no tax payable in US at all when all is added, due to the foreign tax credit given on the US return.

[JGCA]

I agree if they file jointly they will be able to pool theit FTC but I suspect the wife will pay no tax at all on the dividend in Canada so will the tax paid by the spouse be able to cover this, its possible but unlikely I feel.