(Canada)
Learn about your different options on how to pay yourself when you are the owner of an incorporated business.
I was wondering how to go about paying an owner of an incorporated business.
I know there are different options such as paying a salary, paying out dividends at year end, or even income withdrawals throughout the year. How do I decide the best option? The business is just finishing up its first year and it only has one shareholder.
by Jeff MacFarlane, CA
(MacFarlane & Company Chartered Accountant)
Owner Manager Remuneration
Article reprinted with permission
Part three in this series by Jeff MacFarlane, CA has now been published. Enjoy!
Small business owners often ask me if they should be taking dividends from their corporation or paying themselves a salary. There are a few factors to consider in making this decision...but tax usually isn't one of them. Let me show you what I mean.
Let's assume that a business generated net income before tax and owner remuneration in 2011 of $60,000. The owner could take out a salary of $57,782.40 and the corporation would pay the employer's portion of the CPP on that salary of $2,217.60. So the corporation would have no income and pay no tax. The owner would take the salary of $57,782.40 less the deduction for the employee's portion of CPP which is also $2,217.60. He or she would pay personal tax on the salary of $11,592.00. The net amount of cash that the owner gets to put in his or her pocket is $43,972.80.
On the other hand, the owner could decide to take a dividend. The corporation would pay corporate tax on the $60,000 which, in Alberta, would be $8,400. This means the owner's dividend would be $51,600. The personal tax on that dividend would be $3,598. So the cash the owner gets to keep is $48,002.
So by paying a dividend, the owner gets to keep an additional $4,029! But wait a minute. The employee has also earned a pension credit. So that we are not comparing apples and oranges, we should deduct both portions of the CPP which is $4,435.20 from that difference. So really there is about a $406 advantage to taking the salary. And that $406 works out to 2/3 of one percent of the original $60,000. or about 3.5 % of the total tax.
Next month we'll talk about some other things to think about when making the salary / dividend decision.
Part 2 of Salary or Dividend?
by: Jeff MacFarlane, CA
Article reprinted with permission
This is the second part of a three part article discussing whether small business owners should take dividends or salary from their corporation. Last month we ran through the math and I showed you that there is not much of a difference in total tax. But what other considerations might there be?
Well, dividends have two big drawbacks: First dividend income is not eligible income for CPP purposes. That means that if you graduated from high school, started a corporation and paid yourself nothing but dividends, when you turned 65 and applied for your Canada Pension, you would not get one. Second, dividends are not eligible income for RRSP purposes. The amount that you can contribute to an RRSP is based on your eligible income from prior years. Again, if paid yourself nothing but dividends, you would never be able to make an RRSP contribution.
Now these two issues may not be a problem for you specifically. If you have been an employee either of your own corporation or of somebody else, you will already have built up some CPP entitlement. I also have a number of younger clients who are not sure that CPP will be around by the time they want to retire. So instead of paying into the plan they are take the employer and employee contributions that they would be making and investing them themselves.
As for RRSP's, many of us have built up RRSP contribution room from previous employments. This means that we can still make RRSP contributions even though we are now earning only dividend income.
We'll wrap up this series next month with the problem with salaries and some final thoughts.
Salary or Dividends? Part Three
by: Jeff MacFarlane, MacFarlane & Company Chartered Accountant
This is the last of a three part article discussing whether small business owners should take dividends or salary from their corporation. In the first part, we ran through the math and I showed you that there is not much of a difference in total tax. Last month we looked at how paying dividends can adversely affect your CPP and RRSP contributions. Paying a salary has its own set of issues.
First whenever a corporation pays a salary to a related person (the owner or the owners spouse or children) we always have to consider the reasonableness of the salary in relation to the duties performed. If the CRA determines that a salary is not reasonable they could deny the deduction to the corporation while still taxing the recipient. Now the CRA has taken the position that they would not challenge the reasonableness of any salary paid to an owner who is truly active in the business no matter the amount. The problems is the salaries of inactive persons such as the spouse who does a little bookkeeping and promotion. I always tell clients that if they would not pay my spouse the same amount to do the same job then we have a problem. There is no reasonability test for dividends.
The other issue with a salary is just the pain in the butt factor. You have to remember to complete the remittance and pay the withholdings on a salary by the 15th of the following month and do the T4's in February. If you are out of town a lot or not good at paperwork this can be a problem. With dividends we do a T5 once a year and that is it.
The last thing I want to say about the salary / dividend question is that our decision is never written in stone. We can pay salary or dividends or both and we can change the mix at any time. It all depends on the personal situation of the owners.
About the author:
Jeff MacFarlane is the principal of MacFarlane & Company Chartered Accountant. He has been a Chartered Accountant since 1992. After articling with Deloitte & Touche in Calgary, he worked in the tax departments of Chevron Canada Resources and Northstar Energy (now Devon).
His practice has been providing a full range of accounting and tax services for the past ten years. Clients are primarily small, owner-managed businesses. The firm motto is “Helping make sense of business”.
T2Canada.ca is the virtual office of MacFarlane & Company Chartered Accountant.
by Michelle
(Ontario)
Paying owners (shareholders) with a dividend at year end? There are rules ... one which requires a dividend declaration for filing in your Minute Book.
I'm looking for an explanation for shareholders draw being converted to a dividend at year end rather than being paid as employees of the company.
I know taxes are lower on dividends but am not sure of all of the ramifications this has on the owners/shareholders, such as CPP.
Any information would be greatly appreciated.
Comments for CCPC Dividends vs. Salary
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You need to be careful that money you remove from the corporation is not at risk to be taxable. Know the rules!
When a business owner withdraws a personal amount from the business bank account, can you debit shareholder loan account (2000) and credit the bank account?
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by Loretta
(Toronto)
How to Pay Yourself If You Are Incorporated
I am a business consultant who incorporated in Ontario last year. My earnings get deposited into my business acount.
I'd like to draw a small salary in order to take advantage of lower personal tax rates so I withdrew a small amount from my business account and transferred it to my personal account last December. By transferring this amount, does this automatically become personal salary at tax time or do I have to issue myself a T4?
Thanks...
by Sarah
(Mississauga, Ontario)
When can a shareholder / owner manager withdraw money from a corporation tax free?
My client has a incorporated numbered company. They have been drawing/paying themselves from the numbered company bank account, ie; writing a cheque to themselves or withdrawing cash from the business bank account and depositing it into their personal bank account. Therefore those draws are personal income.
My question is where would I enter this income on my clients T1? T2125 is not quite the right wording I was looking for, because my client is not a sole proprietor but the director/owner of this numbered company, which I am doing the T2 for as well.
Line 130/other income seems to vague, it is not a disposition or from dividends, just a cash withdraw or cheque. CRA site is not very informative on this subject.
Thank you very much for any help. :)
by Rosanne
(British Columbia)
I am an incorporated company. I want to start taking a salary.
Do I need to apply for a payroll number with the CRA?
Do I have to deduct EI and Income Tax?
I am 65 so I don't need to deduct CPP.
by Lucy
(Markham)
Management Fee Bonus accrued in 2008, paid in 2009. Is a T-slip required?
Hi,
I'm fairly new at bookkeeping for corporations and deal mainly with small sole-proprietors. This year I took over the books for a small corporation.
Using the Trial Balance and Adjusting Entries provided by the large accounting firm the client deals with for tax planning purposes, I set up the books and am now putting together T-slips.
One of the adjusting entries showed an accrual for a large management fee bonus in 2008. Do I need to put this on a T4 slip or T4A slip?
The only thing the firm could tell me was that it was going to be picked up on the client's 2009 tax return and offered no further assistance.
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How to determine if I should pay employee some money as a "bonus" or "salary"?
I'm setting up payroll for the first time with our company and I want to pay myself a lump sum basically for work that I did last year for free. I can't figure out what makes more sense, to pay it as a salary or a bonus cause I see they are taxed differently.
What difference does it make to me or the company or what? Help?! Thank you!
by Kim
(Canada)
CRA remittances are usually required on Shareholder wages.
When Amending a T4 and T4 summary to add management wages for the Shareholder that were missed, do you have to deduct the tax from the Shareholder, or let him pay it when he files his personal tax return?
I know the CPP must be deducted and submitted, but I thought the tax portion was optional to have the Corporation deduct and pay, or let the Shareholder pay it on his personal return.
I know this is late, but I'm working on this right now, so any help ASAP will be Hugely appreciated. Thanks so much. Kim
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