As the owner-manager of a corporation you may wonder how you should pay yourself; it’s a question we get asked a lot. In this recent post, the various forms of compensation were discussed. Since many corporations have a December 31 year-end, we are talking a lot about year-end bonuses. This post will discuss how a year-end bonus works and the tax deferral benefits available if your corporation has a year-end in the last half of the calendar year.
Bonuses declared before the end of your corporation’s fiscal year can immediately be deducted as long as they are paid no later than the 180th day after year-end. Bonuses, like salaries, are subject to deductions at source. This means that withholdings for income tax, Canada Pension Plan and Employment Insurance (where applicable) need to be made and these source deductions remitted to the CRA shortly thereafter (depending on your corporation’s remittance schedule).
A bonus is typically considered reasonable, and therefore deductible, if it is the corporation’s usual practice to distribute its profits in this way or if the corporation has a policy of declaring bonuses to shareholders to compensate them for the profits earned that are attributable to their abilities, knowledge or inter-personal skills.
How does tax deferral work?
If the corporation’s year-end falls within the latter half of the calendar year (i.e. ending after July 6th), the bonus could be paid out after December 31 (remember, bonuses need to be paid within 180 days). From a personal tax perspective, income is taxable in the year it’s received. This means you would not have to recognize the bonus personally until the next calendar year. Let’s look at an example:
Corporate year-end: October 31, 2015
Taxable income of $50,000
Shareholders declare a bonus of $50,000 to reduce corporate taxable income to zero on the 2015 tax return
If the bonus is paid on January 1, 2016 (or anytime thereafter so long as it’s within 180 days following October 31, 2015), the corporation received a tax deduction in 2015, shareholders received the bonus in 2016 and will include it on their 2016 tax return (filed in the first part of 2017). This provides for a deferral of tax.
What happens if the bonus isn’t paid within 180 days? The deduction for the bonus will be denied and therefore included as part of corporate income. The bonus will be tax deductible when it is paid in the following fiscal year.
If your corporation has a year-end in the latter part of the year, a bonus is often preferred over salary since the payment can be postponed until after the company’s year-end thereby taking advantage of tax deferral.