MODULE 3

Owner-manager Compensation

QUESTIONS

• How am I going to pay myself?

• How can I pay the least amount of taxes?

• Are there any other benefits that I am entitled to being self-employed?

• Is there a way I can split income with family members to save tax?

Paying yourself

Least Taxes

Benefits

PROPRIETORSHIP

• Paying yourself is a simple task: just write yourself a cheque or withdraw cash

• You are paying tax on your “net income” so drawings have no other implications

• You and your business are not separate entities

• If you are making more profit than you need to live, consider incorporation

PARTNERSHIP

• Similar to proprietorship

• Will need to keep track of a partnership capital account

• Capital – How much is available to each partner

Contributions + Net income – drawings

• Should never be in a negative balance

CORPORATION

• Separate entity - tax planning necessary

• Ability to defer taxes

• Tax savings down the road possible

• Planning tools and compensation methods not available to proprietors

• Everyone is different so there is no catch-all method

MAIN COMPENSATION METHODS

1. Pay yourself a salary (payroll)

2. Declare dividends

3. Draws from the corporation

• No right or wrong answer• Will depend on your particular situation• Tax implications are different in all three

situations

SALARIES & WAGES

• You’ll be setup on a company payroll• It’s like working for someone else

Consider the following factors:• your personal living expenses• the amount of money that you draw from the

corporation• your personal tax and investment situation• the overall tax planning strategy applicable to your

situation

SALARIES & WAGES (Con’t)

OBJECTIVE

• Keep any money you don’t need for your personal living expenses in the company

• Taxed at a lower tax rate (15 - 18%)

• Withdraw in the future at potentially a lower rate of tax

• Save taxes in the long run

DIVIDENDS

• Dividends are different from salary

• Paid out of the after tax profits of the corporation, whereas salaries are paid out before corporate taxes

• Not a deduction for tax purposes

• Salaries are deductible expenses

BORROWING OR DRAWING

• Not really a form of compensation

• Borrowing will entail paying the money back or taking the amount into income

• Usually an option upon incorporation when assets transferred into the company

• Repaying back to owners what was originally invested in the corporation

LOGISTICS - SALARY

• Determine what to pay yourself

• Open a CRA payroll account under your business number (RP account)

• Determine the deductions (CPP, EI & tax)

• Write yourself a paycheque for the net amount

• On the 15th of the following month, remit your payroll deductions to CRA

TAX IMPLICATIONS - SALARY

• File a T4 slip and T4 Summary with the CRA by the last day of February each year

• Your T4 slip will be reported on your annual personal income tax return

• Salaries are eligible for RRSP contribution room (18% of prior year salary)

• Corporation will deduct salary paid plus its portion of the CPP and EI expenses

LOGISTICS – DIVIDENDS

• There are no tax remittances for dividends

• Can write yourself a cheque from the company whenever funds needed

• Your accountant will declare dividends and issue a T5 from your company

TAX IMPLICATIONS – DIVIDENDS

• Declare dividends on your personal taxes as per your T5 (gross-up and DTC)

• Dividends are not deductible as an expense to the corporation

• Paid out of after tax profits of corporation

• Investment income to you, therefore not eligible for RRSP contribution room

TAX IMPLICATIONS – LOANS

• Imputed interest benefit – a taxable benefit for use of company’s money

• Must declare the amount withdrawn as income if it is not paid back

• Must be paid by the end of the following fiscal year

• Can’t be a series of loans and repayments

YOUR OBJECTIVES

• Do you want to be collecting Canada Pension Plan benefits when you retire? Are you willing to pay the premiums (both employee and employer) to achieve this?

• Yes I want benefits – Salary• No, I don’t care about CPP - Dividend

• Do you want to contribute to a Registered Retirement Savings Plan as part of your retirement plan?

• Yes, I want RRSP’s - Salary• No, I don’t care about RRSP’s – Dividends

PAYING FAMILY MEMBERS

• Reasonable for the work they are doing

• What would you pay an unrelated person to do the same work?

• Tax savings could be substantial if done properly

PAYING FAMILY - LOGISTICS

• Put family member on payroll and pay them frequently

• Same as any other employee

• Make sure they are actually paid and deposit cheques into their own account

• Properly document hours being worked and ensure pay is reasonable

FUNDING CHILD’S EDUCATION

1. Lend money necessary for tuition and other costs and expenses

2. Include the loan in your child’s income for that year.

3. Once the student graduates, have him/her repay the loan back to the corporation as they begin to earn money.

4. When they do pay back the loan, deduct the amount of the loan on his/her personal income tax return.

ISSUING SHARES TO FAMILY

• Important to setup the corporation right from the start

• Issue different classes of shares to family members and partners/shareholders

Mr. Smith: Class A sharesMrs. Smith: Class B shares

ISSUING SHARES (Con’t)

Reasons for issuing shares:

1. Attracting investors into business

2. Succession planning

3. Rewarding or motivating key employees

4. Income splitting

PAYING DIVIDENDS

• Distributing profit to the shareholders

• No need to worry about family members actually working in business

• Lucrative especially if no other sources of personal income

• Separate classes provide much greater flexibility to split income

SELLING YOUR BUSINESS

• Capital gains exemption if you qualify• Up to $750,000 of capital gains per

shareholder

Qualify?

1. No investment assets in company

2. All assets (90%) used in active business

3. Owned by a Canadian resident or someone related to them

PRIVATE HEALTH SERVICE PLAN

PHSP converts health, medical and dental expenses into fully deductible business expenses

• Company owned – covers owners, employees and their family members

• Low costs to maintain – 10% of medical claim instead of a monthly premium that must be paid regardless

PHSP (Con’t)

• No monthly premiums or deductibles – Not an insurance plan, therefore no monthly premiums

• No medical qualifying – Medical histories of those covered are not a consideration

• Stand alone or supplement existing plan – Can keep existing plan and supplement or top-up those expenses not covered under existing plans

EMPLOYEE PROFIT SHARING PLAN

Problem facing the Canada Pension Plan• The CPP is a pay-as-you-go system. Every time CPP is

withheld and remitting from pay cheques, they go immediately to funding current retired Canadians

• There are currently 5 Canadians working for every 2 that are retired.

• In 25 years due to the aging population, there will only be 2 Canadians working for every 1 retiree

• Thus, CPP premiums will either have to increase or pensions will have to be clawed back or decreased

• You may find that if you are relying on the gov’t to fund your pension, it may not be there

EPSP BENEFITS

• Defer personal income taxes – with a September 30 year end, payments do not have to be made until January of the following year. The income does not have to be reported until the following April 30 (a 19 month deferral)

• RRSP eligible – All income paid out under the EPSP is considered “earned income” under the ITA and eligible in determining the RRSP limit

• Income splitting – The payments distributed through an EPSP are not subject to the same reasonability test as salaries. Therefore ideal for income splitting

• Estate planning – you decide your beneficiaries instead of CPP pension reduced to 60% for spouse

IPP ADVANTAGES

• Greater deductions – Owner able to make annual tax-sheltered contributions that are greater than those permitted by an RRSP

• Creditor proof - IPPs are creditor proof unlike RRSPs in which the creditor proofing has recently been cast in doubt by the courts

• Deductible contributions – all of the contributions made to the IPP are deductible expenses to the Corp

• Surpluses revert to spouse or estate – Unlike other pension plans, when the member dies the assets revert to the spouse or member’s estate

IPP DISADVANTAGES

• Locking-in – plan assets cannot be de-registered as assets must be used to provide a lifetime retirement pension

• Spousal RRSP – an equivalent to spousal RRSPs is not permitted under an IPP. However, the spouse can be enrolled in the IPP

• Contributions are not flexible – The contributions in an IPP are required annually and there are no carry-forward options. In a lower income year, may have to get a business loan to fund the IPP

• Complexity – IPP’s are more complex than RRSPs and the costs to maintain and administer are higher

RETIREMENT COMPENSAION ARRANGEMENT (RCA)

• Vehicle to fund retirement and substantially defer taxes

• Becomes extremely beneficial when a corporation’s profits exceed the small business deduction limit of $400,000

• Make a contribution to the RCA as specified by an Actuarial Certificate. This contribution becomes a tax deduction to the corporation

• The income in the RCA is taxed when it is withdrawn from the RCA at retirement. Can be a substantial tax deferral and tax savings since income at retirement will likely be lower, thus a lower tax bracket

Canadian Small Business Course

www.sbclearnbusiness.com

Visit us online and take the Canadian Small Business Course

Canadian Small Business Course

www.sbclearnbusiness.com

Or take individual modules such as this presentation:

Module 1: Forms of business organization

Module 2: Starting a business step-by-step

Module 3: Compensation strategies

Module 4: Tax planning and strategies

Module 5: Expenses and deductions