December 3, 2013 – Small Business Needs November 2011 Dear Client, If you are a small business owner and you have a corporation, you can compensate yourself with a salary from your corporation, a dividend, or both. This blog uses a decision tree to help you with this.
Small Business Needs – Salary or Dividends or Both? Decision Tree for Compensating Yourself from Your Corporation
If your corporation’s income exceeds $500,000, then you should pay yourself a salary or what accountants call a “bonus” to reduce your corporation’s income below $500,000, so your corporation does not pay tax at a high rate.
If an RRSP is an important investment vehicle for your retirement, you can pay yourself a salary to maximize your RRSP contribution room.
If your company is an important investment vehicle for your retirement, then any additional amounts that you need for your personal lifestyle needs should be paid out as dividends from the corporation.
Let’s look at the issues and tax implications associated with each of these steps of the decision tree:
Pay Yourself or Your Family a “Bonus” if your Corporation’s Income Exceeds $500,000
Small business corporations can earn $500,000 of income and pay corporate income taxes at a rate of 15.5% in Ontario, otherwise the tax rate jumps to 28.25% on income in excess of $500,000, or almost double.
Therefore it is important to “bonus” out to the owner a salary which can be deducted by the corporation to bring the corporation’s income below $500,000.
The “bonus” can include payments to the owner’s family for income splitting purposes.
Pay Yourself a Salary to Maximize Your RRSP Contribution Room
Your RRSP contribution room is calculated as 18% of your “earned income” from the prior year (salary is “earned income”, while dividends are not).
If an RRSP is important to you as an investment strategy for your retirement, then the owner’s salary should be enough to maximize the following year’s RRSP contribution.
Since the maximum RRSP contribution limit for 2012 is $22,970, then $127,611 is the salary or “earned income” required in 2011 in order for the owner to contribute the maximum $22,970 RRSP (18% of $127,611 is $22,970).
Pay Yourself a Dividend if Your Company is Your Retirement Vehicle
The marginal personal tax on a salary can range from 24% to a high rate of 46%, however, the corporate tax on earnings up to $500,000 in Ontario is 15.5%.
Therefore, keeping profits in the company and having them taxed at the low rate of 15.5% allows more money to accumulate within the company to invest for your retirement, compared to the after-tax amount invested in your RRSP.
When you liquidate your investments in your company, capital gains are currently 50% taxable at the low 15.5% corporate tax rate, whereas cashing in your RRSP is 100% taxable at your marginal personal tax rate.
Other considerations such as the risk associated with keeping your retirement funds within your operating company can be resolved with a holding company structure.
Stay tuned… It’s that time of year again to discuss Year End Tax Tips in my next Personal Income Tax blog! Notice to Reader Dean Constand C.G.A. publishes this newsletter for information purposes only. Feel free to distribute to colleagues and friends. Although the material has been carefully prepared, it is not a substitute for professional advice.