How to get money out of your business, tax effectively!
One of the most common questions I am asked by entrepreneurs is:
How do I pay myself?
There are, in fact, several ways of taking money from your business for your personal use.
If you are a proprietorship, i.e. an unincorporated business, it could not be easier. Just write yourself a cheque. A proprietorship pays tax on the profits of the business, before taking account of owner’s draws. So whatever is left over after paying expenses is available to the owner for either their personal use, or to pay taxes and CPP, which is calculated on their personal tax return. There is no ability to defer tax, and a limited ability to split income with other family members.
Where it becomes more complicated, and also more beneficial, is when you incorporate. Corporations can compensate its owners ad employees in several ways.
Employees are paid by salary for the work they do for the corporation. The corporation is responsible for deducting and paying the taxes and CPP and gives the employee their net pay. Owners are very often also employees, and can be paid by salary. However, a non-working family member is technically unable to receive a salary, as they have done no work.
Results of taking a salary
- The company gets a tax deduction for the salary and pays less tax.
- The employee pays into CPP
- The employee gets to increase their RRSP eligibility, thus allowing them to save for retirement and receive a tax deduction today.
- Taxes are deducted at source, and the employee can spend all the money they receive.
An alternative is to take a dividend. Dividends can only be paid to the shareholders of the corporation. However, as the dividend is a return on the investment in the shares owned and not compensation for work done, a shareholder can be paid any amount of dividend, as long as all shareholders holding shares of that class are paid their share. Thus a non-working spouse can receive a dividend, even if they have no involvement in the business operations.
Dividends have different tax rules than salary
- They are paid out of after tax earnings of the corporation and are not tax deductions to the corporation.
- They do not give the recipient any eligibility for CPP or RRSP.
- However, as they have been partly taxed in the corporation, the individual pays less tax on a dividend than they would on a salary.
- In fact, if the recipient has no other income, they can receive up to $26,000 tax free.
Owner managed corporations must look at the tax paid personally versus tax paid in the corporation to determine the best compensation route. This varies in every situation, but with careful planning, an astute owner can significantly minimize their tax bill and increase their take home pay.