Taxes on income. Can. Q

[My Dream]

This question relates to Canadian taxes. Ok, ok, I just found out (and I'm hoping I have the right info) that capital gains is taxed at 50% and dividends are taxed at 100%, therefore my question is, why would you want to get dividend income if it's taxed alot higher?
By the way, just for the record, when I joined this forum I was told that I'm allowed 3125 questions, I have 3104 questions left.

 

[bosco]

This question relates to Canadian taxes. Ok, ok, I just found out (and I'm hoping I have the right info) that capital gains is taxed at 50% and dividends are taxed at 100%, therefore my question is, why would you want to get dividend income if it's taxed alot higher?
By the way, just for the record, when I joined this forum I was told that I'm allowed 3125 questions, I have 3104 questions left.

the exact amounts depend upon your tax bracket, but the short answer is that capital gains are taxed at 50% of your ordinary income rate. Divididends are taxed at 100% their own rate which for most tax brackets is less than 50% of your ordinary income rate.

Exact rates also depend on the province. For more details, check out

http://www.ey.com/GLOBAL/content.nsf/Canada/Tax_-_Calculators_-_2006_Personal_Tax

 

[My Dream]

Thanks bosco, now (before I read the link you provided), why would someone invest in something if you have to pay twice as much tax, and assuming you're getting the same rate of return?

 

[retire@40]

This question relates to Canadian taxes. Ok, ok, I just found out (and I'm hoping I have the right info) that capital gains is taxed at 50% and dividends are taxed at 100%...

With tax rates that high, you might want to consider joining the "fair" tax gang. I hear everyone pays much less under that scheme plan.

 

[Meadbh]

Thanks bosco, now (before I read the link you provided), why would someone invest in something if you have to pay twice as much tax, and assuming you're getting the same rate of return?

My Dream......

From the investor's POV, it is more tax efficient to invest in growth stocks that generate a capital gain when sold. However, growth and volatility are correlated (think tech sector 1998-2000). Hence, investing for capital gains is associated with more risk. Capital gains are realized only on sale. OTOH, stocks that pay dividends are usually those of established companies in a more stable state. The capital gains are usually lower than those of a growth stock, but the risk of major loss when the stock is sold is lower. You get to keep the stock and the dividend too. In fact, you can use the dividends as a very tax efficient income stream.

From the Federal Government's POV, the decision to tax capital gains at 50% rather than 100% was meant to encourage investment in growth companies and stimulate the economy. Why is the government less interested in stimulating investment in government bonds, which also generate dividends, at present? Because it is using the surplus to pay down debt and has no need to take on any more.

Hope this helps!

Meadbh

 

[bosco]

Thanks bosco, now (before I read the link you provided), why would someone invest in something if you have to pay twice as much tax, and assuming you're getting the same rate of return?

they wouldn't but what you will discover from the link I provided is that your assumption that dividends are taxed higher than capital gains is, for the most part, incorrect. You have been tripped up by the language.

only 1/2 your capital gains are taxed, but they are taxed at the full ordinary rate, so the effective rate is 1/2 as much.

dividends are taxed on the full amount, but the rate is different and lower.

ultimately, dividends are taxed less.

 

[MasterBlaster]

The other issue is the certainty of return. For many companies the dividends are steady but the capital gains are uncertain.

Therefore to induce people to invest in capital-based investments the capital gains rate is lower than the tax on dividends.

 

[AltaRed]

only 1/2 your capital gains are taxed, but they are taxed at the full ordinary rate, so the effective rate is 1/2 as much.

dividends are taxed on the full amount, but the rate is different and lower.

ultimately, dividends are taxed less.

Correct. For capital gains in Canada, if your marginal personal tax rate is 40%, you pay 0.4(0.5)CG = tax.

Dividends are a lot more complex. They are grossed up, then a dividend tax credit applies to the result and the resultant effective tax rate is very low relative to all other taxable income. The Feds changed the dividend tax rules this year and then each province enacted changes for provincial income tax. For those interested, check the "new dividend income tax rules" thread on FWF here

http://www.financialwebring.com/forum/viewtopic.php?t=101749&postdays=0&postorder=asc&start=105

 

[kcowan]

As a simple example, you can earn about $30k in dividends as your only income and pay no tax at all. With $30k in CG, you would pay tax on $15k of income (not much but more than zero).

Naturally such an example has a bunch of assumptions to be accurate, but you get the general idea.

 

[My Dream]

Correct. For capital gains in Canada, if your marginal personal tax rate is 40%, you pay 0.4(0.5)CG = tax.

Dividends are a lot more complex. They are grossed up, then a dividend tax credit applies to the result and the resultant effective tax rate is very low relative to all other taxable income. The Feds changed the dividend tax rules this year and then each province enacted changes for provincial income tax. For those interested, check the "new dividend income tax rules" thread on FWF here

http://www.financialwebring.com/forum/viewtopic.php?t=101749&postdays=0&postorder=asc&start=105

I reread all the posts up untill AltaRed and didn't quit understand it. I do understand the statement above.

For all those that posted a reply, I truly appreciate you're response but at this point it has to be put in simple terms untill I get more familiar with the terminology and better understand investing. Please be patient, it's going to take me some time.

I'm still trying to figure out how to take a several quotes like Nords does and respond to them.

 

[My Dream]

As a simple example, you can earn about $30k in dividends as your only income and pay no tax at all. With $30k in CG, you would pay tax on $15k of income (not much but more than zero).

Naturally such an example has a bunch of assumptions to be accurate, but you get the general idea.

I didn't think you could make close to that and not pay tax. Thanks for the info.

 

[Nords]

I'm still trying to figure out how to take a several quotes like Nords does and respond to them.

If the quote is all from one person's post:
1. Click the "Quote" button.
2. Right-click on the text in the "Message" box and choose "Select All".
3. When it's all highlighted, right-click again and choose "Copy".
4. Scroll to the bottom of the message text, left-click the cursor to position it after all the text (make sure it's after the "[/quote]" formatting), right-click yet again, and choose "Paste".
5. Repeat step 4 until you have enough copies to handle all the comments you're going to make.
6. Scroll up to the first block of quoted text and edit it until it shows what you want to see. The formatting requires that it begin with "[quote author...]" and end with "[/quote]" or it won't display correctly, but anything between those format brackets is fair game.
7. Move your cursor to the next blank line after the quote and type your response.
8. Repeat steps 6 & 7 on subsequent quote blocks until you run out of copies.

If the quotes come from several different posters:
Execute steps 1-3. That quoted text (with its formatting) is now on your operating system's clipboard.
4. Click the "Back" button on your browser to return to the thread and find the next post you want to quote. Click its "Quote" button.
5. Position your cursor (perhaps at the very beginning of that quoted text before the formatting, or maybe at the end of all the formatting), right-click, and select "Paste". Edit away and post when ready.
6. If you're feeling cocky and you want to go for three or even more quotes by different posters, then after pasting in your quote do another right-click, "Select All", right-click, "Copy", and repeat steps 4-5.

Simple, no?

As a matter of fact, yes, that is what I do all day...

 

[AltaRed]

I reread all the posts up untill AltaRed and didn't quit understand it. I do understand the statement above.

What part do you not understand?

 

[My Dream]

With tax rates that high, you might want to consider joining the "fair" tax gang. I hear everyone pays much less under that scheme plan.

What is the "fair" tax gang.......maybe a joke?

My Dream......

Hence, investing for capital gains is associated with more risk. Capital gains are realized only on sale. OTOH, stocks that pay dividends are usually those of established companies in a more stable state. The capital gains are usually lower than those of a growth stock, but the risk of major loss when the stock is sold is lower. You get to keep the stock and the dividend too. In fact, you can use the dividends as a very tax efficient income stream.

I don't understand the underlined quote.

How can you use dividends as a very tax efficient income stream if it's taxed at 100% rather then the capital gains at 50%?

they wouldn't but what you will discover from the link I provided is that your assumption that dividends are taxed higher than capital gains is, for the most part, incorrect. You have been tripped up by the language.

only 1/2 your capital gains are taxed, but they are taxed at the full ordinary rate, so the effective rate is 1/2 as much.

dividends are taxed on the full amount, but the rate is different and lower.

ultimately, dividends are taxed less.

If dividends are taxed at the full amount, how is the rate different and lower. Keep in mind that I'm trying to think outside the box, and still can't get it. Also I've never filed out my own tax returns.

As a simple example, you can earn about $30k in dividends as your only income and pay no tax at all. With $30k in CG, you would pay tax on $15k of income (not much but more than zero).
Naturally such an example has a bunch of assumptions to be accurate, but you get the general idea.

How can you earn $30k in income and not pay tax, personal exemption is just over $9k isn't it?

The underline quote states that you would pay not much tax on $15k but the above quote says no tax on $30k.



Nords, thanks so much for the explanation, I hope I did it correctly although this was my second attempt, the first one got accidently deleted, and I was pissed. Believe it or not this post took me more than an hour to do.

What part do you not understand?

There's more that I don't understand but this is the basics, I hope you're not sorry you asked.

 

[bosco]

If dividends are taxed at the full amount, how is the rate different and lower. Keep in mind that I'm trying to think outside the box, and still can't get it. Also I've never filed out my own tax returns.

here's a simple example: 50% of a 40% tax rate = 20% (cap gains)
100% of a 15% tax rate = 15% (dividiend)

the exact numbers might be slightly different--this is just an example. The point is that the tax rate on dividends is different than on ordinary income. The tax rate on cap gains in 50% of the tax on regular income. But usually, the effective tax rate you pay on dividends is less.

Look at the website I posted and plug in some numbers--I think you'll see what I mean.

 

[My Dream]

Bosco, there are several things I didn't understand regarding the chart in the link, for eg. what and why the difference between "Marginal Tax Rate" And "Average Tax Rate" 2ndly, why is Dividend income at a different rate then Capital, I checked and it's not half?

 

[My Dream]

I pluged in some numbers into that calculater you provided and went as high as $34,750 before the marginal tax rate of dividends moves from 0% while marginal tax rate of capital gains was at 10.65. This is for Ontario. To me that doesn't make sense.


I am so comfused.............I may have to think about going back to work cause I just don't get this............NOOOOOOO tell me it ain't so!~

 

[Meadbh]

OK, let's try a concrete example:

"Capital gains are usually lower than those of a growth stock, but the risk of major loss when the stock is sold is lower. You get to keep the stock and the dividend too. "

Suppose you buy 100 shares of Company A at $5 a share. It's a Growth Stock, a new business with great potential but no profits yet. Over the next year, the share value rises to $15. If you sell all your shares, you will make a capital gain of $15-$5 = $10 per share, or $1000.

Now suppose you are in a 35% marginal tax bracket. That is, every extra dollar of income is taxed at 35%. How much extra income tax will you pay because you sold the shares of Company A?

Answer: $1000 X 0.35 X 0.5 = $175.
The 0.5 comes from the fact that capital gains are taxed at 50%.
Amount left for you (profit) = $1000 - $175 = $825, or 82.5% of the money you made by selling the shares.

Because Company A is in the Growth Phase, it is investing every spare dollar in research, development and marketing, so there are no dividends. And of course, the business might tank, and you could be left with 100 shares valued at $0.50 each! That's what they call "downside risk". Nortel was one example!!!!

Now let's consider Company B. This is a well established company (e.g. Sobey's, Royal Bank) which is not going to go bust anytime soon, is generating profit, and has good cash flow. You buy 100 shares of Company B at $50 a share. In the next year, the share price rises to $60. If you sell the shares, your capital gain will be $10 X 100 = $1000 and you will pay capital gains tax as before.

However, Company B issues yearly dividends to its shareholders. Let's say the dividend is 5% of the share value and it is distributed soon after you buy it, when the share price is still $50. You now have a dividend of 0.05 X $50 X 100 = $250. This happens whether you sell your shares or not. But if you do sell your shares at the end of the year, no dividend for you next year!

Let's say you like the idea of getting dividends every year and decide to keep the shares of Company B. How much income tax will you have to pay on the dividends?

Here comes the complicated bit. The federal government multiplies the dividend by 1.45 (called the 45% grossup). Then, they calculate a tax credit of 11/18 of the grossup. This amounts to ~28% of the actual dividend. A tax credit is actual money you save.

So in this case, again assuming you are in a 35% marginal tax bracket, you would pay

$250 X 1.45 X 0.35 = $126.88 minus the tax credit of $250 X 0.28 = $70, or $56.88. That leaves you with $250 - $56.88, or $193.12, 77% of your original dividend.

In this example I have simplified by ignoring provincial dividend tax credits because they vary. I have also assumed that in both cases the person's marginal tax rate was 35%. However, a retiree could use a portfolio of dividend stocks to generate his/her entire income, and the stocks would still be there to generate dividends next year. If your entire income was generated from dividends, you would have your personal tax credit without any tax, and the next chunk will be taxed at about 21% minus the tax credit, which can actually result in a negative number! (However, I don't think Revenue Canada will actually pay you!)

TaxTips.ca has a table of taxes payable in different provinces. The Ontario table is at this URL: http://www.taxtips.ca/ontax.htm

Here is another quote from TaxTips.ca:

"For an individual with no income other than taxable Canadian dividends which are eligible for the enhanced dividend tax credit, approximately $66,000 can be earned before any federal taxes are payable."

Nice, eh?

 

[bosco]

Bosco, there are several things I didn't understand regarding the chart in the link, for eg. what and why the difference between "Marginal Tax Rate" And "Average Tax Rate" 2ndly, why is Dividend income at a different rate then Capital, I checked and it's not half?

Marginal tax rate is the tax rate on the next dollar you earn. In other words, if you've already made $35,000, your marginal tax rate at $35,000 is the rate you'd pay on the next dollar you made above that amount.

Average tax rate is the rate you get by dividing the total tax you pay by how much you made. It is virtually always lower than your marignal tax rate in a progressive tax system.

Dividend tax rate is not half--it varies but is usually less than half the ordinary rate. Capital gains taxes at your ordinary income rate, but only half the amount of the capital gain is taxed. Sounds confusing but is actually quite simple.

 

[My Dream]

Meadbh , I really appreciate the time it must have taken you to write down those detailed examples. I've read them twice and seem to understand it better the more times I read it. Thank you so much.

bosco , I also appreciate your explanation. I guess that this will probably be the only way I'm going to get a grasp of how the investment world works. I know it's going to take some time and I hope that some members can help along the way. To some of you this may be second nature, but to me it's a whole new world.

Thanks again.

MD

 

[Meadbh]

You're welcome, My Dream!

One more thing: "enhanced" dividend tax credits came about in the 2006 Federal Budget. The companies must be public and Canadian. So this does not apply to dividends from small private corporations, e.g. my medical corporation.

The website I mentioned is easy to follow on current tax information and the Revenue Canada site is relatively easy to read too. Also consider looking up the Canadian Taxpayers Federation at
http://www.taxpayer.com/main/news.php?type_id=1&topic_id=9

If you are a newbie to personal finance, David Chilton's The Wealthy Barber is not a bad place to start. If you have the basics and have the time and interest to learn a whole lot more about finance, take a look at the Canadian Securities Course (www.csi.ca).

 

[My Dream]

You're welcome, My Dream!

One more thing: "enhanced" dividend tax credits came about in the 2006 Federal Budget. The companies must be public and Canadian. So this does not apply to dividends from small private corporations, e.g. my medical corporation.

The website I mentioned is easy to follow on current tax information and the Revenue Canada site is relatively easy to read too. Also consider looking up the Canadian Taxpayers Federation at
http://www.taxpayer.com/main/news.php?type_id=1&topic_id=9

If you are a newbie to personal finance, David Chilton's The Wealthy Barber is not a bad place to start. If you have the basics and have the time and interest to learn a whole lot more about finance, take a look at the Canadian Securities Course (www.csi.ca).

Funny you should mention that book since that is the only financial type book I have ever read in my life. I read it about 20 years ago and that was the changing point in my FI life. It taught me the value of saving and all about compound interest. Not being fully retired, I need to make the most of my money. I know right now, I'm not.
Thanks Meadbh

 

[bosco]

bosco , I also appreciate your explanation. I guess that this will probably be the only way I'm going to get a grasp of how the investment world works. I know it's going to take some time and I hope that some members can help along the way. To some of you this may be second nature, but to me it's a whole new world.

no problem, MD.

I'm still learning how to deal with the taxes systems of both countries. Although born in Canada, some 60% of my financial assets are in the US. The tax systems of the two countries are quite different. I find the following website

http://www.financialwebring.com/forum/

to be a much better source of information on Canadian taxes and investments than here. This site is mostly geared to the US. If you haven't checked the link, you might want to look into it.