The following is a contributed post from Mike Pinkus, CPA, CA and Lior Zehtser, CPA, CA, co-founders of ConnectCPA, a virtual accounting firm that leverages technology to bring simplicity to the lives of business owners.
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As a Canadian business owner it is important to understand the different ways in which you can pay yourself. (After all, that’s one of the main reasons you’re in business, right?) There are three primary ways to get this done, each with its own advantages and disadvantages. So let’s dive and help you learn how to pay yourself!
In order to pay yourself a salary as a business owner, you must first set up a payroll account with the Canada Revenue Agency (CRA). This is a simple process where you can contact the CRA business line and they can set up the account. The payroll account will contain the same business number as your corporation but will contain an “RP” as opposed to the “RC” that is at the end of your corporate business number. When you pay a salary from your corporation, it will be a deduction that will reduce your corporate net income, however you will be taxed on the salary you receive on your personal tax return.
The payroll process, including how much to deduct, when to deduct and where to remit can be simplified by outsourcing this function to a payroll service provider. If you operate in the cloud, this process is further simplified as you can integrate your payroll data with your accounting system. This new form of integration makes what used to be a daunting task, effortless.
The amount of room available to make a contribution to your Registered Retirement Savings Plan (RRSP) is based on your prior year’s “earned income.” Therefore, paying a dividend instead of salary will limit the room available to make a contribution to your RRSP in the following year since dividends do not count towards “earned income.” As an RRSP contribution results in an income tax deduction, the increased room available is a major advantage of paying a salary.
Salary is also considered a provable form of income for purposes of obtaining financing such as a line of credit or a mortgage on a home. Since you have pay-cheques, pay-stubs and a T4 slip, you can easily provide evidence to the bank to substantiate your earnings.
When you make salary payments, you are required to remit Canada Pension Plan (CPP) contributions. Although it is not a major source of cash flow at retirement, by contributing to CPP it gives you the eligibility to receive a pension once you reach the age of sixty-five.
You can create a large tax deferral by paying yourself a bonus if you have a corporate year-end in the last half of the calendar year. You have 180 days to pay a bonus while still being allowed to take a deduction in your corporation. The result is that you lower your corporate taxes by the amount of the bonus, however you do not declare the income personally until the following tax year because you received the actual funds subsequent to Dec 31.
When you pay a salary to yourself, you have to remit tax deductions and Canada Pension Plan (CPP) contributions to the CRA. Many business owners consider this a disadvantage as this requires additional administrative work and a loss in cash-flow in the short run. Many corporate shareholders will not be required to remit Employment Insurance (EI), however, if you employ any employees, you will have to remit CPP, source deductions and EI on their behalf. As previously mentioned, a payroll service provider can assist in simplifying this process by calculating the deductions and making the remittances on your behalf.
Dividends are paid out of the profits of a corporation. In order to pay a dividend you must set up an RZ account with the CRA. Dividends are paid out to the shareholders of a corporation in proportion to each shareholders’ ownership in the corporation. When you pay a dividend, you are required to issue a T5 slip which is subsequently included in the recipient's personal tax return.
Dividends are less of an administrative headache. You do not have to make CPP contributions or remit source deductions on a monthly basis. From an administrative standpoint, all you have to do is pay yourself and record the details in your corporate minute book. In 2014, you can pay a dividend of just over $40,000 without a significant federal tax liability (assuming you have no other sources of income). However, one should note that you have already paid corporate taxes on the amount you are paying as a dividend, so it is not a significant advantage over salary.
It’s worth noting that you have already paid corporate taxes on the amount you are paying as a dividend, so it is not a significant advantage over salary. And as previously mentioned, dividends do not count towards earned income and therefore do not contribute to your RRSP contribution room.
The general concept for a shareholder loan is that all capital that you have contributed to your business can be withdrawn on a tax-free basis. This includes all capital that you initially contributed to the corporation, in addition to all future contributions to the corporation and all purchases made on behalf of the corporation using personal funds. The main reason you can withdraw funds from the shareholder account on a tax-free basis is because all of the above noted contributions are made with “after-tax” dollars.
As long as you do not withdraw more than what you initially contributed to the business, you can pull the money out of it on a tax-free basis against your shareholder loan account. There is no administrative work related to taking out the money. Additionally, you can borrow money from your corporation as long as you pay a required prescribed rate of interest as set out by the CRA. A unique advantage of the shareholder loan account is that the mandated timelines to pay back the loan without incurring any interest or penalties is 365 days from the end of your fiscal year end. For example, if you have a December 31, 2014 year end, you could borrow money from your corporation on January 1, 2014 and will not be obligated to repay it until December 31, 2015. This is a great way to borrow funds from your corporation for a personal purchase, such as a home. Just be sure to have the necessary funds available in time to meet the repayment deadline, otherwise the implications could be punitive.
If you draw too much money from your business so that you end up owing the corporation money, you have one year from your fiscal year-end date to pay it back or it will be included in full in your income. To avoid this penalty you would have to pay your corporation a prescribed rate of interest as set out by the CRA and as noted above.
As expected, there are many layers of complexity to each method of paying yourself through your corporation. And just wait until you have employees! While this article provides a high-level overview of the topic, it does not substitute the expert advice of a payroll specialist or an accountant. Contact yours and they’ll help you figure out what’s best for not only your business, but also you.