Canadian Corporate Owners Compensation – Options
One of the many complex aspects of owning a corporation is how you, as the owner, decide to compensate yourself. A business owner of a corporation can become very confused with the various options open to him or her. This article will shed some light on a complex area.
When businesses typically start, the owners invest their own money. Usually this is classified as a shareholder loan. In other words, money is slow to the corporation from the owners to buy supplies, equipment, furniture, etc. This money is expected to be returned to the owners of the corporation once the corporation is profitable.
When the corporation starts to make money, the owners start writing checks from the corporate bank account for their own personal needs. A well-organized business owner will write a check to himself and deposit it into his personal bank account. Every time a check is written to the owners, the shareholder’s loan decreases. In other words, these checks represent a repayment of the owner’s original loan.
At some point, the owner’s original loan has been paid back. When a Corporation reaches this point, the owners have to deal with any funds that have been withdrawn from the corporation on their personal tax returns. This can be a very confusing time for most corporate business owners.
There are two options that can be used to recognize this income on the owners’ personal tax return. One option is to consider the amount as a salary. The other is to recognize the amount as a dividend. Each of these approaches has its own positives and negatives.
A salary is identical to the payments made to any employee. Deductions for federal taxes, CPP (Canada Pension Plan) and EI (Employment Insurance) are made each time the salary is paid (ie, biweekly, biweekly or monthly). The net amount becomes the part that is deposited in the owner’s bank account. Salary deductions are submitted to the government.
The advantage of an owner receiving a salary is that the owner contributes to both the CPP and sometimes the EI. This allows the owner to take advantage of these programs in the future. It also provides the owner with an RRSP contribution room that can be used in the coming year. The salary also becomes an expense in the corporation, so the amount of corporate tax due is less. The recurring nature of the salary provides a stable source of funds for the owner to pay for his personal expenses and provides a constant remittance to the government for taxes that will eventually have to be paid.
The only disadvantage of the salary strategy for a business owner is the fact that it is difficult to maintain if the corporation does not have a constant source of cash. In other words, the salary to the owner will require the payment of source withholdings in the middle of next month. If a corporation is having a slow month, this can be difficult.
The other approach used to recognize money paid to an owner is to issue dividends. Dividends are usually declared at the end of the year and represent the amount of money the owner has taken out of the corporation. Unlike salaries, dividends do not generate payments to either the CPP program or the EI program. There is also no immediate need to file deductions or source taxes with the government. Instead, the money is due when the individual files their Personal Tax Return in April of the following year. So the advantage of dividends is greater flexibility in paying taxes.
It should also be noted that taking salary instead of dividends or dividends instead of salary does not actually change the amount of tax paid. In the case of salaries, the money is taxed entirely in the hands of the owner and is not taxed within the corporation. Dividends, on the other hand, are taxed first within the corporation and then again on the owner’s personal tax return. However, the tax system ensures that the total tax of the dividend approach is practically the same as that of the salary approach.
Corporate business owners will eventually have to face the dilemma of declaring a salary or a dividend. Both approaches result in paying roughly the same amount of tax. The approach an owner uses will depend on the owner’s philosophy and cash flow situation.