We’ve all heard the mantra “pay yourself first,” either in reference to an investing strategy, or making a living as a business owner. However, most business owners have an additional concern. They want to know: “How do I to pay myself enough to maintain a reasonable standard of living, while maximizing the health of my business?”
Integrating tax management into your remuneration strategy, just like in your business plan, can help ensure you’re working with the tax system, not letting it work against you.
To keep things simple, examples will be for a business that’s been incorporated. The owner of an incorporated business can receive a salary, dividends, or a combination thereof. A corporation is entitled to a lower tax rate — between 11% and 19% depending on the province/territory — on the small business taxable income threshold of up to $500,000, and a higher general corporate tax rate — between 25% and 31% depending on the province/territory — on any income above $500,000. When determining the best strategy to pay themselves a salary or a dividend, business owners should be asking the following questions:
How much money do you require? By taking only what you require, you can take advantage of the significant deferral opportunity by retaining after-tax profits in the corporation, as the corporate tax rate is significantly lower than the top personal marginal tax rate.
Is there a need for employment income (rather than dividends) to make RRSP contributions or to benefit from tax deductions, for example from those related to childcare? If the answer is yes, then at least a portion of your compensation must be in the form of a salary or bonus.
Is the corporation eligible for scientific research and experimental development tax credits? If yes, then it may be critical to keep corporate profits at or below $500,000 to take advantage of additional refundable credits, many of which are available to the corporation only if profits do not exceed $500,000. In this case, the corporation will need to pay shareholders or employees an amount that brings profits down to the threshold.
— Do you have a spouse and/or children 18 years of age or older with little to no other sources of income? If yes, then consider income-splitting strategies, whereby income that would otherwise be taxed in your hands is instead paid to and taxed in the hands of taxpayers with a lower marginal rate. One strategy could be the payment of dividends to these family members, but that could require a reorganization of the capital of the corporation first.
Developing a strategic approach to remuneration is something nearly all business owners will agonize over. While it’s an essential part of how you run your business, it should be part of a larger tax management strategy that fits into your business plan.
As the saying goes, one of the certainties in life is taxes. By making sure your business is working with the tax system, you can avoid penalties, take advantage of tax credits and pay yourself what you’re worth.
This article was originally published in the Financial Post.
About the Author
Silvia Jacinto is a tax partner at Crowe Soberman and specializes in corporate and personal tax planning.