2026 Ontario Budget small business tax cut paired with less favourable tax changes

Always read the fine print. It’s a rule of thumb that can help mitigate risk and avoid a plethora of financial challenges, at least for those who choose to follow it. That advice could apply to a measure proposed (and since passed) in the 2026 Ontario Budget, which reduces the Ontario small business corporate income tax rate to 2.2 per cent from 3.2 per cent on the first $500,000 of active business income. The total effective combined federal and Ontario provincial small business tax rate will decrease to 11.2 per cent from 12.2 per cent. The change takes effect on July 1, 2026.

The measure was a signature item in the budget and was welcomed by businesses across the province. Less discussed was this proposal:

“As dividends are paid out of after‐tax corporate earnings, individual shareholders are eligible for personal income tax relief through the federal and Ontario dividend tax credits, the rate of which approximates the CIT rate paid by the corporation. To align with the reduction in Ontario’s small business CIT rate, Ontario’s small business (non‐eligible) dividend tax credit rate would be reduced from 2.9863 per cent to 1.9863 per cent, effective January 1, 2027.”

That credit reduction will push the top personal tax rate on non-eligible dividends to 48.89 per cent from 47.74 per cent. This tax increase could have a significant impact on corporations with investment income, effectively negating the CIT rate cut for those affected. In addition, the combined corporate and personal tax on investment income will spike to about 58.86 per cent from 57.93 per cent, thereby boosting the tax burden from income earned through a corporate structure.

So, what are small to medium-sized business owners that maintain a corporation to do given this change? One option for those with retained earnings (specifically from income taxed at the small business rate) may be to accelerate non-eligible dividend payments before the dividend tax credit change takes effect in 2027. Doing so will help to lock in that higher Ontario dividend credit and reduce tax exposure.

Other affected entrepreneurs may choose to rebalance the distribution of salary and dividends from their corporation, reaping benefits such as reducing passive income exposure and creating RRSP room. These are only a handful of many potential mitigation options. Always consult your KRP Partner or Tax Manager to discuss tax strategies tailored to your specific needs.

While not a major tax hike, per se, when combined with passive income rules, the dividend tax credit change will create potential disadvantages for some small to medium-sized business owners. The measure also reminds us that even seemingly favourable tax adjustments are worth a deeper look to ensure they aren’t offset by corresponding tax increases.

In other words, always read the fine print.

Armando Iannuzzi, Co-Managing Partner

For more information on measures announced in Ontario’s 2026 Budget, contact a member of the KRP LLP team today.