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Dividend 'gross-ups' a gross out for some seniors

Last week's column on the dividend tax credit - in particular the "gross-up" of dividends - touched a raw nerve.

One reader called the gross-up a "pity," and said it needs to be "looked into and corrected." Another called it a "horrible monster only a politician could possibly dream up."

What is it about the gross-up that elicits such outrage, especially among seniors?

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The short answer is that it makes their income look larger than it actually is. And that can result in a reduction of income-tested benefits such as Old Age Security and the age credit for people over 65.

These aren't the rantings of an isolated few, either.

"It is a significant issue," says certified financial planner Jim Kraft of PlanningWise Inc. in Markham, Ont., who estimates that more than a third of his clients are affected.

"The Old Age Security clawback is a huge one, because now the gross-up is pushing your income much higher. These are the things that really rise up and catch people sideways."

For years, people tolerated the gross-up when it was just 25 per cent. But when Ottawa jacked the rate up to 45 per cent in 2006 as part of its efforts to stem the tax leakage from income trusts, the gross-up became an issue for more people.

To take a simple example, someone earning $1,000 in dividends now reports $1,450 in income on his or her tax return. The dividend tax credit slashes the tax payable on the dividends, but because Ottawa includes the grossed-up amount when determining OAS and various credits, the poor investor ends up getting punished for income he or she doesn't actually receive.

Mr. Kraft, who is also a chartered accountant, says middle-income seniors are hit especially hard. The gross-up can also cut into spousal credits, eligible dependent credits, caregiver credits, medical expense credits and the Canada Child Tax Benefit, he says.

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The good news is that there are ways to reduce the hit. The bad news is the methods are often complicated and require the services of a professional.

When aiming to minimize the impact of the gross-up, the first step is a thorough review of a person's portfolio to determine whether - and to what extent - dividend stocks are an appropriate investment, Mr. Kraft says. In some cases, it may make sense to create a corporation to hold the investments, which prevents the individual from receiving the dividends directly and facing a gross-up.

Investing in securities with special tax treatment - such as real estate investment trusts or flow-through shares of energy and mining companies - is another option. But one has to be mindful of the risks, which can be significant, particularly in the case of flow-through shares.

"You can't invest purely for tax minimization because that's when people get into trouble," says Kerry Harman, associate portfolio manager with Burgeonvest Securities Ltd. in Toronto. "Then you load yourself up with some pretty speculative stuff."

Pina Perruccio, senior financial adviser with Kerr Financial Corp. in Toronto, agrees that choosing investments solely for tax reasons is asking for trouble. Sometimes, shifting dividends from one spouse to another, adjusting the asset mix or transferring dividends into a trust can help minimize the impact of the gross-up.

In other cases, doing nothing may be the best option.

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"As a planner we'd run the numbers to make sure, but it just might be something you have to endure," Ms. Perruccio says.

Fortunately, the pain won't be as severe in coming years: The gross-up is set to fall to 44 per cent in 2010, 41 per cent in 2011 and 38 per cent in 2012.

At the same time, however, the federal dividend tax credit is also set to decline, so dividends will be taxed at a higher rate.

What's the point of grossing up dividends?

It may seem like a random act to confuse and terrorize investors, but there's a rationale behind it.

"It's a question we get asked a lot," says Brian Quinlan, partner at Campbell Lawless Professional Corp. chartered accountants in Toronto. "The idea is to put you on the same footing as the corporation was before tax because you're a shareholder."

When a company makes a profit, it pays tax on its earnings and then distributes dividends to shareholders out of what's left.

In effect, the gross-up of dividends reverses the process, approximating the pretax income required to pay those dividends.

The individual then claims a dividend tax credit on the grossed-up amount, "so you're kind of getting credit for the tax the corporation paid," Mr. Quinlan says.

Confused yet? The important point is that the gross-up and tax credit system reduces so-called double taxation of dividends.













DTC as % of grossed-up dividend





DTC as % of actual dividends






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About the Author
Investment Reporter and Columnist

John Heinzl has been writing about business and investing since 1990. A native of Hamilton, he earned a master's degree from the University of Western Ontario's Graduate School of Journalism and completed the Canadian Securities Course with honours. More

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