Did you know that as a small business owner, you can distribute tax-free dividends to yourself using a Capital Dividend Account (CDA)?
Understanding the potential of a CDA can significantly reduce your tax burden, keeping more money in your pocket.
In this blog post, we'll demystify CDAs, explaining what they are, how they work, and how you can leverage them to maximize your tax benefits.
Whether you're new to the concept or looking to optimize your financial planning, this article will provide you with the essential insights you need to keep more of your hard-earned money.
P.S. If you'd rather have Joe explain it, you can also check out this video 👇
What is a Capital Dividend Account (CDA)?
A Capital Dividend Account (CDA) is a nifty tool that Canadian private corporations can use to distribute tax-free dividends to their shareholders.
Essentially, it allows you to pay out the non-taxable portion of your capital gains as dividends without having to worry about the taxman knocking on your door.
How Does the Capital Dividend Account Work?
The best way to learn is by looking at an example, so here's a step-by-step breakdown using a scenario where you sold an investment for $100,000.
Step 1: Calculate Your CDA Balance
First things first, you’ll want to figure out how much you can actually pay out as a capital dividend.
1. Review Past Gains and Losses:
Suppose your corporation had a capital loss of $20,000 in a previous fiscal year and no other capital gains or losses in any other year.
2. Current Year's Capital Gain:
Now, you sold an investment for $100,000, with a cost basis of $60,000. That gives you a capital gain of $40,000.
3. Net Capital Gain Calculation:
You need to net this gain against your previous loss: $40,000 (gain) - $20,000 (loss) = $20,000 net capital gain.
4. Determine CDA Balance:
Half of this net capital gain is your CDA balance: $20,000 x 50% = $10,000. So, you can pay out approximately $10,000 as a capital dividend.
Step 2: File the CDA Election Forms
Before you can pay out this capital dividend, you have to let the Canada Revenue Agency (CRA) know what you're up to. This involves filing a Capital Dividend Election form (T2054).
1. Prepare the Form:
This form needs to be completed and submitted before you pay the dividend to avoid any nasty penalties.
2. Desired Payment Date:
Make sure your payment date is after you've filed these forms. It's usually a good idea to wait until the CRA processes your form to confirm your CDA balance.
Step 3: Pay the Capital Dividend
Timing is everything!
1. Post-Approval Payment:
It's best to wait for CRA approval before paying out the dividend to avoid any penalties if there's a discrepancy.
2. Potential Risks:
If you decide to pay the dividend before getting CRA approval and there's a disagreement about your CDA balance, you might face penalties.
A Few Important Points
Processing Time of CRA election forms
Right now, the CRA can take several months to process CDA election request forms. So, plan ahead.
CDA Balance Validity:
The CDA balance is cumulative and doesn't expire. However, remember that the desired payment date must be after the filing date to avoid penalties.
By following these steps, you can make the most of your CDA and enjoy the benefits of tax-free dividends.
If you need any help with preparing and filing the CDA election request forms, just provide us with the details of your investment sales and confirm any other capital gains or losses since your last fiscal year-end.
Understanding and managing your CDA properly can offer significant tax benefits. Just make sure you stick to the proper procedures to maximize these benefits and stay on the CRA's good side.
If you have any more questions or need further clarification, feel free to reach out. We're here to help!
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