“My business is incorporated, how should I pay myself?”
Your business is incorporated and you’re wondering what’s the best way to pay yourself. It is a great question since there are a few options and it’s important to understand your choices and their differences.
The three main ways you can pay yourself are:
- salary/bonus
- dividends
- shareholder loan
Want to know more? Read on for a discussion of each.
Salary/Bonus
When you receive a salary, it’s a tax deduction for your corporation and taxable as employment income on your personal tax return.
What you need to know:
– requires the deduction and remittance of income tax and CPP
– need to issue a T4 slip and file it with the CRA
– earned income and therefore provides you with RRSP contribution room
– provable form of income for purposes of obtaining financing (i.e, line of credit, loan, mortgage)
– requires CPP contributions, making you eligible to receive a pension once you reach the age of sixty-five
– if your corporation’s year-end is in the last half of the calendar year, you have the opportunity to defer taxes by paying yourself a bonus. How? In order to be tax deductible, a bonus has to be paid within 180 days. You are taxed on the bonus when the funds are received. So, if you receive the funds after December 31, they’re reported on your tax return a year after the corporation claimed the tax deduction. This can be a bit confusing and is an important opportunity for tax planning so let’s use an example.
Corporate year-end: September 30, 2015
Bonus declared $25,000
Corporation pays the bonus January 5, 2016
Since the corporation paid the bonus within 180 days, it can claim $25,000 as a tax deduction for the September 30, 2015 year-end. Since you didn’t receive the funds until January 5, 2016, they’ll be included on your 2016 personal income tax return (prepared in 2017). This is called tax deferral since you are delaying the payment of taxes to a future period.
Dividends
When you receive a dividend, it’s paid out of your corporation’s after-tax profit and reported as investment income on your personal tax return.
What you need to know:
– need to issue a T5 slip and file it with the CRA
– record the details of the dividend payment in your corporate minute book
– doesn’t require source deductions/remittances
– if CPP and RRSP are important to you, dividends don’t enable to you to contribute
Shareholder Loan
All the capital you contributed to your corporation can be withdrawn tax-free.
What you need to know:
– funds can be withdrawn from your shareholder account tax-free because they were made using “after-tax” dollars
– if you withdraw more than what you contributed, there are rules around the treatment of the funds you owe the corporation. There are mandated timelines to pay back the loan without interest or penalties; you have 365 days from the end of your fiscal year end. As an example, if the corporate year-end is December 31 and you take money out on January 1, 2016, you have until December 31, 2017 to repay. If you’re unable to repay the money, you have to pay your corporation a prescribed rate of interest (this rate is set by the CRA) or declare the amount of the borrowed funds as income on your personal return.
Final Thoughts
This is an overview of ways to pay yourself; there are exceptions and/or processes associated with each option. There are also different tax rates for salary and dividends and two types of dividends. This stuff can get complicated! It’s important to know that while each method was discussed individually, you can pay yourself using a combination; you’ll often hear the term “salary/dividend mix”. Unfortunately there isn’t a standard “mix”; it needs to be based on your unique situation and objectives.
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