MX Wholesale Ltd. is a Canadian-controlled private corporation located in Ontario. The company regularly earns pre-tax profits of $600,000.
The common shares of MX are owned 50/50 by Mr. and Mrs. Waldman. Only Mrs. Waldman works for the business, and she is paid a substantial salary for her efforts. Mr. Waldman is a lawyer and earns a large income from his law firm. In addition, the Waldmans receive annual dividends from MX. The company has consistently maintained a policy of distributing half its after-tax profits to the shareholders.
The Waldmans are dismayed at the amount of tax both they and the corporation must pay when corporate profits are distributed. They have asked you to explain to them the tax effect of distributing the corporate profits. In addition, they intend to sell the shares of the company in the next two or three years and want you to explain what the effect would be if they stopped paying dividends from MX.
The assumed provincial income tax rate in Ontario is 11.5% for corporations. However, the corporate rate is reduced to 4.5% on income eligible for the small-business deduction. Both Waldmans have already used up their capital gain exemption. The marginal tax rate the Waldmans personally pay is 46% on regular income, 30% on Eligible dividends, and 33% on Non-eligible dividends.
Required:
1. What rate of tax are the Waldmans paying on the profits of MX that are distributed to them annually (corporate and personal tax combined)? Show calculations.
2. Should the Waldmans stop paying dividends? Your answer should indicate how their overall tax rate would be affected.