The Capital Dividend Account is one of the most powerful tools a business owner can use, but very few are using it.
This secret notional account could save you millions of dollars in tax.
What is a Capital Dividend Account?
A Capital Dividend Account (CDA) is generally used by Canadian business owners with a Canadian-Controlled Private Corporation.
This account provides a phenomenal tax advantage, allowing you to withdraw money from the corporation completely tax-free.
The CDA balance is accumulated by the non-taxable portion (50%) of capital gains the company earns and death benefits from a corporate-owned life insurance policy. Both flow through the CDA and are distributed to shareholders for tax-free withdrawal.
However, capital losses can reduce the balance to zero or negative and prevent you from withdrawing. When this happens, more capital gains can offset the balance.
Be mindful of the balance available for payment in the CDA. There are tax penalties if your corporation pays you more capital dividends than what is available.
Making Use of the Capital Dividend Account
Here are two of the many ways you can make use of the CDA:
Tax-free flow-through of capital gains
When a Canadian-Controlled Private Corporation earns a capital gain, 50% of that gain (known as the non-taxable portion) flows through the CDA. Shareholders can then take this out of the corporation tax-free in the form of capital dividends.
For example, if you earn a $100,000 capital gain, you have a $50,000 taxable capital gain. The other $50,000 is capital dividends you can pull out completely tax-free.
Make sure your investment structure inside your corporation is a capital gains vehicle that allows the capital dividend credits to accumulate.
Tax-free insurance payouts
If you own life insurance inside your corporation, the death benefits can be paid tax-free through the CDA.
It’s important that the corporation is set up as the beneficiary and the shareholder as the person insured. So, when the insured passes away, the death benefit will be paid out to the corporation, and your family can access the death benefit tax-free from the CDA because you are a shareholder of your corporation. It’s important to note that this credit using life insurance is only created at the time of a claim.
Another tax benefit of corporate-owned life insurance is you get to pay for the premiums with corporate dollars that are taxed at a much lower rate.
Not only will your family save thousands in tax when they withdraw the death benefits tax-free, but you’ll also be able to keep more money in your pocket from what you saved by paying the premium with corporate dollars.
Read More: Gov’t of Canada: Income Tax Folio S3-F2-C1, Capital Dividends