Summary and Takeaways
If you are an incorporated Canadian entrepreneur or business owner, you probably earn money through a salary or bonus – which is a deductible business expense but fully taxable on your personal tax returns as earned income. Or you may be compensated through dividends that aren’t deductible as a business expense – but offer some tax benefits to you personally. As is always the case when it comes to tax law, the rules can be complicated. But by understanding them and applying certain strategies, you can potentially lower your taxes to help preserve and grow your wealth.
- Every Canadian entrepreneur or business owner with a corporation should have an integrated annual remuneration strategy as part of their overall financial plan.
- The Canadian tax system is designed to equalize the total tax you pay, regardless of whether you receive salaries and bonuses or dividends.
- But how those methods of compensation are integrated can vary substantially from one tax jurisdiction to the next. The available tax-saving strategies will also vary accordingly.
- Experts strongly advise consulting a specialist in business owner remuneration planning, in order to optimize your success and minimize your tax liability.
If you are an incorporated Canadian entrepreneur or business owner, there are two general ways to pay yourself from your corporation:
- Salary/bonus – this is a deductible expense to your corporation, but fully taxable to you personally as employment income.
- Income tax, employee/employer Canada Pension Plan (CPP) contributions, and employee/employer Employment Insurance (EI) contributions (assuming no election out of EI) are withheld at their source, and must often be remitted to the Canada Revenue Agency (CRA) by the 15th day of the month following payment of the salary/bonus.
- Your corporation can pay a bonus up to 180 days after your corporation’s fiscal year-end, and still deduct it for corporate tax purposes in the fiscal year for which it is declared.
- Dividend – this is not a deductible expense to your corporation but is taxed at a lower overall tax rate to you personally, as a result of the dividend gross-up and dividend tax credit mechanism.
- There is no tax withheld at the source, and CPP and EI are not payable on dividend income. This can often lead to you having to pay tax personally on dividends received, and/or being subject to personal quarterly income tax installments.
- Your corporation must at least record the dividend payment by its corporate fiscal year-end.
The Canadian tax system is designed for integration, which aims to equalize the total tax paid − whether income is received as a salary/bonus or a dividend. However, the degree of integration varies by province/territory due to different tax rates, and there may be potential small advantages/disadvantages for total corporate and individual tax payable for each province/territory. These should be evaluated based on the current changes in tax rules and rates.
The salary/bonus and dividend options to pay yourself from your corporation have different personal and corporate tax implications. Those will vary for each person, and each unique set of circumstances. The best approach for you to take should be discussed with a knowledgeable tax accountant and financial planner. But these are some key factors to consider:
- The first $500,000 of active business income (ABI) earned by a Canadian-controlled private corporation (CCPC) is eligible for the small business deduction (SBD), resulting in a lower rate of tax payable. The SBD corporate tax rate is 9% federally and then ranges from 0% to 3.2% (depending on the province/territory of your corporation), for a maximum total of 12.2%. These SBD corporate tax rates are in comparison to the general corporate tax rates of 15% federally and 8% to 16% (depending on the province/territory of your corporation), for a maximum total of 31%.
- Note that Saskatchewan’s provincial SBD rate is extended to $600,000 of active business income.
- Assuming you do not require funds from your corporation to fund your personal lifestyle, they can be left within your corporation. That defers the personal level of tax liability until they are paid out of the corporation. This can result in years of tax deferral. and is a major advantage of using a corporate structure.
- Assuming you do require the funds from your corporation to fund your personal lifestyle, then you need to decide whether to pay the funds from your corporation as a salary/bonus or as a dividend.
- If your corporation earns more than $500,000 of ABI annually, then the amount in excess of the $500,000 SBD limit ($600K for Saskatchewan) can be paid from your corporation in the form of salary/bonus. This ensures no corporate tax is payable on ABI at the general corporate tax rates, and only the lower SBD corporate tax rate is paid.
- The build-up of passive assets inside your corporation (assets not reinvested back into the active business) can eventually disqualify your corporation for the purposes of the Lifetime Capital Gains Exemption (“LCGE”). That can even claw back the amount of ABI eligible for the SBD. Once your corporation has a passive investment income of greater than $50,000 in any taxation year, each additional dollar of passive investment income reduces the $500,000 of ABI eligible for the SBD by a factor of $5. That fully eliminates the $500,000 of ABI eligible for the SBD at $150,000 of passive investment income per year.
- The use of a proper corporate structure and purification transactions, to remove excess passive assets, can help ensure that your corporation continues to qualify for the LCGE.
- Assets retained within your corporation, whether passive or reinvested back into the active business, are exposed to your corporation’s creditors.
- The use of a separate holding company through the proper corporate structure can help to limit the number of assets exposed to creditors.
- If you do not receive a salary/bonus from your corporation, it is possible that no contributions are made for you to CPP in that calendar year. This can result in receiving a lower amount of CPP income in retirement. It can also result in a loss of CPP disability benefits in the event that you become disabled before retirement.
- These negative consequences can be addressed through other savings strategies and adequate disability insurance coverage. You may even find that comparable disability insurance coverage is more affordable than the cost of paying the employee and employer premiums for CPP on a salary/bonus.
- Paying a salary/bonus is beneficial if:
- You have a personal investment/retirement strategy that involves making contributions to your Registered Retirement Savings Plan (RRSP), a spousal RRSP, and CPP.
- You are paying childcare expenses and are the lower-income spouse/common-law partner. Childcare expenses are not deductible when dividend income is the only source of income.
- You want to deduct expenses on your personal tax return related to use of your personal vehicle for business purposes.
- You are subject to personal Alternative Minimum Tax (AMT) and would like to reduce or eliminate it.
- It is important to pay personal expenses yourself, and keep company expenses separately paid through your corporation. If company funds are used to pay personal expenses, you will owe reimbursement in that amount to the company (i.e., it’s treated as a shareholder loan from your corporation to you). This shareholder loan needs to be repaid by you within one year of the end of your corporation’s taxation year. Otherwise, it will be considered taxable income to you as a shareholder and may not be deductible by your corporation, resulting in double-taxation.
- If you have a shareholder loan that is from your corporation to you, this should be reviewed as soon as possible. A strategy for repayment or an offsetting salary/bonus/dividend to you from your corporation should be developed.
- Alternative ways to receive funds from your corporation are to 1) return paid-up capital or 2) pay-down shareholder loans from you to your corporation. However (unlike a salary/bonus or dividend), these alternatives are often not available each year.
- You should consider employing your spouse or partner and/or your children to take advantage of income-splitting opportunities. Their salaries must be reasonable for the work they perform. Unlike dividends, salaries are not subject to the Tax on Split Income (TOSI) rules. Also, consider whether or not your industry is subject to Workplace Safety and Insurance Board coverage in your province/territory.
Please note that if you are also a U.S. citizen, additional tax and remuneration planning will be required that is beyond the scope of this article.
Every Canadian entrepreneur or business owner with a corporation should have an integrated annual remuneration strategy as part of their holistic financial plan. To review your current strategy or discuss how to optimize your annual remuneration, investing, and retirement strategies, please reach out to Cardinal Point.