As a business owner, you work day in and day out to grow your business and your efforts deserve a monetary reward. In addition, you need to earn a regular income to cover your personal expenses. The question is how can you draw an income from your business in a way that is tax-efficient and meets your personal and professional financial needs? Once your business is incorporated, it becomes a separate entity. As a business owner, you must decide how to pay yourself. Should you opt for a salary, a dividend, a shareholder loan, or a combination of the various options?
This article will take you through a comparison of each of the three methods, to help you make informed decisions.
How Much Income Should You Draw from Your Business?
Before determining how to pay yourself, you have to determine how much to pay yourself. Paying too little could result in a precarious personal financial situation, while overpayment could negatively impact your business and/or result in over taxation. Hence, a good place to start would be to closely examine your business profits in order to maintain an adequate profit to pay ratio. This will help keep your employees, business partners, and other shareholders happy as well.
But keep in mind that underpaying yourself to keep others happy is not wise either. Evaluate the nature of your work, the hours you put in, and the value you add to the business. Then determine how much you would have earned for doing the same job as an employee. Once you arrive at a reasonable amount, it is time to decide on your best payment method.
How to Get Paid as a Business Owner
You can decide to pay yourself a monthly salary or flexible dividends depending on the proportion of shares you own. Between the two, there are various tax implications to keep in mind:
- Salary is calculated as an expense so it reduces your corporate profits and thereby corporate tax.
- The dividend is calculated on the after-tax profit and so it brings no corporate tax benefit. But it provides benefits for your personal income tax calculation as dividend tax is lower than a regular salary.
Taking Payment as Salary
If you decide to pay yourself a salary, you must follow the Canada Revenue Agency (CRA) payroll process. You will need to create a payroll account, pay yourself a fixed amount every month, and deduct the Canada Pension Plan (CPP), Employment Insurance (EI), and income tax as you would for any other employee. As the business owner, you will have to bear both the employer and employee contribution of the CPP and EI. At the end of the financial year, you must issue yourself a T4 slip.
When you file your income tax returns, you can use various tax-saving instruments like the Registered Retirement Savings Plan (RRSP) contributions to lower your personal income.
Salary processing might look like a lot of administrative work. But if you already have employees, adding one more employee (yourself) won’t make much difference as your payroll process is already in place.
The next thing to consider is whether taking income as a salary could serve your financial purposes.
Are you looking to accumulate retirement savings through options such as the CPP and RRSP? The CRA will allow you to use RRSP contributions to reduce your earned income by up to 18% to a maximum of $27,830 (for 2021). This can be a significant benefit to earning a salary.
You might also consider taking a salary if you plan to apply for credit or a mortgage. A salary will allow you to demonstrate a regular income with the necessary documentation to a financial lender.
If none of the above circumstances apply to you, dividends may be a better option.
Taking Payment as Dividend
Unlike salary, dividends are not administratively overbearing. There is no frequency of dividend payments as they are paid out at the discretion of the company directors. You can pay yourself dividends anytime during the fiscal year, although it is possible to maximize the tax benefits depending on your personal tax situation.
To make dividend payments, you need to first set up an Information Return account with the CRA. Whenever you withdraw dividends, you will write a check payable to you, update the dividend action in the corporation’s minutes book, and prepare the director’s resolution. At the end of the financial year, the business will need to issue you a T5 slip for your personal tax filing.
Unlike a salary, dividends are taxed at a lower rate, which could bode well for your income tax. But there is no corporate tax benefit to paying a dividend, unlike a salary, as dividends are paid from the post-tax business. Keep in mind that if you only receive dividend income, you won’t be eligible for the benefits associated with RRSP contributions.
Taking Payment as a Shareholder Loan
As a business owner, you can withdraw any capital you have personally contributed to the business through the shareholder loan account. There is no administrative process, and you can withdraw the full amount of your contribution tax-free. However, the timing of taking and repaying a shareholder loan becomes important for tax purposes. f you withdraw more than your contribution, you only have one year to repay the excess amount to avoid any penalty or tax.
Contact Sloan Partners LLP for Guidance on the Best Method to Pay Yourself as a Business Owner
There is no one-size-fits-all solution when it comes to paying yourself from your business. You can analyze the pros and cons of each method or opt to use a combination depending on your financial requirements. Speaking to an experienced accountant will help you identify the most tax-efficient manner in which to pay yourself. The team at Sloan Partners LLP can review your options with you, as well as the benefits and liabilities of each as they specifically apply to you. Contact us by phone at 416-665-7735 or reach out online.