Owner-manager remuneration: How should I pay myself?
One of the most common questions that our owner-manager clients ask is: What is the most tax efficient way to take out funds from my company? There is rarely a simple answer to that question, because the choice of remuneration depends on the unique circumstances of an individual. This blog post will explore some of the common factors that we’ve seen, when helping our owner-manager clients make this decision.
The Canadian tax system is based on a theory of integration. This means that an individual should be indifferent between earning income directly or through a corporation and paying out the funds as dividends. In other words, the overall tax burden should be the same regardless of the business structure that is selected.
In most cases, owner-managers must decide between salary or dividends. Unfortunately, there is no obvious answer as to which one is best. Neither of the two would result in significant costs or savings, so the decision on how to pay yourself will depend on your specific circumstances.
- Cash needs
The most important question is: do you need the cash personally? If you have sufficient personal cash for your lifestyle, then the best option may be to leave the money in the corporation. This would allow you to take advantage of the tax deferral opportunities. For example, for small business income earned in Ontario, the deferral is 40%. This would leave you with more funds to invest inside the corporation. However, given the recent changes to the taxation of corporate passive investment income, the owner-manager should be careful with deferring too much.
If you are looking to build up the savings in your RRSP, you will need to receive a sufficient salary to maximize your contributions. In order to make a maximum RRSP contribution in 2020 of $27,230, you will need to draw a salary of $151,278 in 2019.
IPPs are an effective tool to minimize corporate tax, while providing for your retirement. In order to implement an IPP, you must have a history of significant T4 income.
If you would like to receive CPP in retirement, you will need to receive salary up to the maximum pensionable earnings amount. For 2019, this amount is $57,400 and is projected to increase to $82,700 by 2025.
- Income level of family members
If some of your family members work for your company, and their income levels are low, then it may be beneficial to pay them dividends. For instance, an Ontario taxpayer with no other income may receive $52,069 of eligible dividends or $26,369 of ineligible dividends, tax-free (Ontario Health Premium may apply). In order to pay dividends to your family members, they must work for your business/practice at least 20 hours/week. Otherwise, punitive tax consequences would result in the application of top marginal rates to those dividends. If your family members do not meet the “20 hour/week” requirement, then consider paying them a reasonable salary.
Peter and Nadia are owner-managers and residents of Ontario. They each drew a salary of $150,000 in 2019. They decided to renovate their family home and required an additional $100,000. Their initial plan was to pay themselves a dividend (ineligible) of $50,000 each, which would have resulted in additional family taxes of approximately $41,000. They asked us if there was a more tax-efficient way to withdraw the $100,000 from their corporation. We analyzed their corporate and personal information and came up with a couple of alternatives:
- Eligible dividends
Based on our analysis, we discovered that their corporation had a General Rate Income Pool (GRIP) balance, which enabled Peter and Nadia to receive eligible dividends. Eligible dividends are taxed at a lower personal tax rate as compared to ineligible. By paying out $50,000 as eligible instead of ineligible dividends to Peter and Nadia each, their family tax bill would be reduced by approximately $9,300.
- Capital dividends
We also noticed that their corporation had a balance in the Capital Dividend Account (“CDA”). This allowed Peter and Nadia to receive “capital dividends” which would not be subject to personal tax. Therefore, they could receive the full $100,000 tax-free and save $41,000 in personal taxes.
A non-taxable portion of a capital gain realized by a corporation is added to the capital dividend account. This enables individual shareholders to receive capital dividends, which would be tax-free. In some cases, it may be possible for a corporation to internally trigger unrealized capital gains and generate an addition to the capital dividend account.
The remuneration question does not usually have an easy answer. As demonstrated in the example above, the most tax efficient way to remove funds from a corporation is via a capital dividend, which would not be subject to personal tax. However, where this is not an option, an owner-manager must decide between salary and dividends. This choice is usually not driven solely by tax savings, but rather by individual circumstances and preferences of an owner-manager.
Feel free to get in touch to start a conversation on how to make this decision.
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