Managing personal compensation as a business owner in Canada demands a comprehensive understanding of the intricate financial and tax landscape. Determining an appropriate salary and exploring diverse payment methods involve navigating complex tax and legal considerations. In this blog post, we will provide you with a guide on how to pay yourself as a business owner, covering different strategies and key considerations.
KEY CONSIDERATIONS
Understand Your Business Structure
The first step in determining how to pay yourself is to understand the legal structure of your business. In Canada, businesses typically operate as sole proprietorships, partnerships or corporations. Each structure has its own implications regarding taxation, liability, and compensation methods. Consulting with a legal or financial professional can help you choose the most suitable structure for your business and ensure compliance with applicable laws and regulations.
Maintain Financial Separation
Maintaining a clear distinction between personal and business finances is paramount. Open a dedicated business bank account to track income, expenses, and personal payments efficiently. By segregating personal and business finances, you can accurately monitor business profitability while demonstrating the legitimacy of personal payments.
COMPENSATION METHODS
Salary and Wages
For business owners operating as corporations, paying yourself a salary or wages as an employee is a common practice. Adopting this approach ensures consistency in income and allows you to leverage employment-related deductions. Establish a payroll system to facilitate accurate deductions for income taxes, Canada Pension Plan (CPP) contributions, and employment insurance (EI) premiums from your salary. Collaborate with an accountant or a reliable payroll service provider to manage the necessary calculations, ensuring compliance with payroll regulations.
Tip: You’ll need to first set up a payroll account with the Canada Revenue Agency (CRA).
Tax considerations: When you pay a salary from your corporation, it will be a deduction that will reduce your corporate net income. You will be taxed on the salary you receive on your personal tax return.
Dividends
Shareholders in corporations can receive compensation in the form of dividends, which are distributions made from the company’s after-tax profits. Dividends are subject to distinct tax treatment compared to salaries, often taxed at a lower rate. Dividends are paid out to the shareholders of a corporation in proportion to each shareholders’ ownership in the corporation. Consult with an accountant to determine the ideal balance between salaries and dividends based on your personal and business circumstances.
Tip: You’ll need to first set up an ‘Information Return (RZ)’ account with the CRA.
Tax considerations: When you pay a dividend, you are required to issue a T5 slip which is subsequently included in the recipient’s personal tax return.
Owner’s Draw/Shareholder Loans
For sole proprietors and partnerships, the owner’s draw serves as a prevalent method for personal compensation. An owner’s draw entails withdrawing funds directly from the business’ profits or cash reserves for personal use. Unlike salaries or dividends, owner’s draws do not involve payroll deductions or tax withholdings. However, meticulous tracking and documentation of these transactions are essential for accurate tax reporting.
In a corporate setting, owner’s draws (or shareholder loans) need to be tracked carefully as there are significant tax consequences if the draws are in excess of any shareholder contributions.
Tip: Use an accounting system to easily track all the transactions related to shareholder loan amounts and transfers so that you have a live and real time balance. This will allow you to understand how much of a shareholder loan you can withdraw.
Tax considerations: If you draw too much money from your business so that you end up owing the corporation money, you have one year from your fiscal year-end date to pay it back or it will be included in full in your income (unless you pay your corporation interest).
CONCLUSION
Effectively managing personal compensation as a business owner in Canada necessitates a thorough understanding of legal, financial, and tax-related aspects. Irrespective of the chosen payment method above, understanding the tax implications is crucial. Seek guidance from a tax professional to ensure compliance with federal and provincial tax laws. And pay close attention to personal income tax obligations, as well as any corporate/personal tax requirements such as tax instalments and payroll remittances.
To further understand how to pay yourself from your business Contact Abdullah CPA for Consultation.
