Kevin Greenard: The Greenard Group’s 10 items to consider – salary or dividends?

Our skilled shoppers and enterprise homeowners who’re included (mixed we’ll refer to each as “enterprise homeowners”) should juggle a couple of totally different balls when it comes to figuring out company versus private taxation, and the general mixed tax results. One possibility is to have all earnings maintained, and taxed, inside the company. The problem with this strategy is that homeowners of firms typically want private money circulation to stay off to fund residing bills.
Canadian small enterprise homeowners who require money circulation from an organization usually have two essential selections on how to draw funds out – salary or dividends. Over the years, I’ve had prolonged conversations with shoppers, and their accountants, about which technique is preferable. From an earnings tax perspective, a enterprise proprietor ought to, in principle, discover no benefit with one possibility over the opposite, because of the tax idea of “integration.”

The Concept of Integration
For a Canadian enterprise proprietor, earnings tax integration is predicated on the premise that a person incomes earnings via an organization ought to be in the identical tax place as if the person earned the earnings personally. When a salary is paid, the corporate deducts the quantity when calculating its taxes, ensuing within the proprietor having it taxed at his or her relevant private tax price. In the case of a dividend, company earnings tax is paid first, and the after-tax quantity is paid to the proprietor.
A “grossing up” of the dividend quantity together with a private tax credit score accounts for the company tax paid. This ends in the dividend being taxed at a most popular price personally, and when mixed with the company tax paid, ought to lead to the identical quantity of tax paid as within the salary instance.

The (*10*) of Integration
Unfortunately, the speculation of integration is often not good in observe. It varies with modifications in earnings tax charges, province of residence, laws modifications, and every shoppers’ distinctive scenario. In quick, good integration isn’t achieved.
The idea of integration very often focuses on a shorter-time period outlook. Our view of working with shoppers focuses on minimizing mixed earnings taxes (each private and company) over your lifetime.
A call to select dividends over salary could make sense in a given yr, whereas the other could also be true in a distinct yr. Income tax, together with different concerns outlined on this article, requires an evaluation primarily based on a person’s personal scenario, often on an annual foundation.
Greenard Group’s 10 Items to Consider
Many components want to be thought-about by enterprise homeowners deciding on receiving earnings as salary or dividends. The Greenard Group’s prime ten dialogue areas with shoppers relate to Registered Retirement Savings Plans (RRSP), Registered Account Carry-forward limits, Payroll Remittances, deductions for the corporate, earnings splitting with household, energetic enterprise earnings, stage of passive earnings, stability of earnings, flexibility and ease, debt financing, and property planning.
We will use three totally different enterprise homeowners to illustrate: Business Owner #1 pays a $100,000 salary, Business Owner #2 pays a $100,000 dividend, and Business Owner #3 retains funds inside the company and pays neither a salary nor a dividend.
1) Registered Retirement Savings Plan (RRSP)
Business Owner #1 decides to obtain a salary of $100,000 and goes to obtain a T4 exhibiting this quantity. The T4 salary quantity is taken into account earned earnings for the aim of producing Registered Retirement Savings Plan (RRSP) contribution room. After the tax return is filed, Canada Revenue Agency (CRA) will calculate the eligible contribution room as 18 per cent of the earned earnings, which is proven on the Notice of Assessment.
In this illustration, $18,000 ($100,000 salary x 18 per cent = $18,000) is the extra RRSP contribution room that’s generated and quantity that may be contributed to a RRSP. The 18 per cent calculation does have a most that’s listed every year. For 2021 the utmost RRSP contribution restrict is $27,830. If you divide $27,830 by 18 per cent, then the utmost threshold is met when a salary reaches $154,611 for 2021.
Business Owner #2 decides to obtain a dividend of $100,000. Since dividend earnings shouldn’t be thought-about earned earnings, no RRSP room could be generated.
Business Owner #3 decides not to obtain a salary or a dividend. Since there isn’t any private earned earnings, there could be no RRSP room generated.
2) Registered Account Carry-forward
In many conditions, now we have shoppers which have RRSP room and Tax-Free Savings Account (TFSA) deduction restrict which were carried ahead from previous years. In Canada, you probably have been supplied with contribution room, and you haven’t beforehand used the room, then this may carry ahead to future years.
If an proprietor has important RRSP carry ahead room that has by no means been utilized, then paying a salary for the aim of producing extra RRSP room is probably not a main issue. If alternatively, a enterprise proprietor doesn’t have any RRSP deduction restrict, then producing RRSP room by paying a salary could also be extra of a consideration.
3) Payroll Remittances
One of the components that ought to be thought-about is whether or not payroll remittances are required.
Business Owner #1 who receives an annual salary of $100,000 should change into acquainted with the required payroll withholding taxes, equivalent to Canada Pension Plan (CPP) and Income Taxes. A payroll system should be put into place with further administrative and accounting steps.
Business Owner #2 who receives an annual dividend of $100,000 doesn’t have to be involved about doing company payroll withholding and filings. Payments of dividends aren’t topic to CPP, Employment Insurance (EI), or payroll taxes.
Business Owner #3 has no payroll items to cope with.
4) Deductions for the Company
Business Owner #1 that receives an annual salary of $100,000 is in a position to declare the salary as an expense inside the company. The expense reduces the taxable earnings inside the enterprise. As a end result, the company would pay decrease company taxes.
For Business Owner #2 that receives dividends of $100,000, the dividend is paid from retained earnings (after tax income). Essentially which means the cost of dividends shouldn’t be a company deduction or expense.
Business Owner #3 has no deductions inside the company and no funds of after-tax income as no distributions are made.
5) Income Splitting With Family
Salaries supply a versatile means to redistribute enterprise earnings when relations are employed within the enterprise. Any salary paid should be affordable in relation to the providers carried out.
Dividends contain much less administration and don’t require the recipient to carry out providers for the enterprise. If the recipient owns shares of the corporate, then dividends supply a way to distribute after-tax income to relations which are shareholders.
It’s typically really useful to keep away from paying dividends to shareholders which are minors, since dividends from a non-public company to minor kids are taxed on the highest private tax price, typically referred to because the “Kiddie Tax.” Under the brand new Tax on Split Income (TOSI) guidelines that had been efficient Jan. 1, 2018, this may even be prolonged to associated grownup relations (“specified people”) except exclusions apply.
The guidelines are expanded to embrace sure money owed, capital positive factors and second-technology earnings, casting a a lot wider internet. These guidelines usually apply to specified people that aren’t actively engaged within the enterprise or don’t contribute a “affordable quantity” of capital or labour to the associated enterprise. These modifications are meant to scale back earnings splitting alternatives by taxing these people on the highest marginal tax charges.
It is necessary to observe that the TOSI guidelines don’t apply to break up earnings if the enterprise proprietor’s partner is age 65 or older. Often at occasions, the technique could shift to paying the partner a dividend. As famous above, the partner shouldn’t be required to carry out providers for the enterprise.
Business Owner #3 could have chosen to maintain as a lot funds inside the company as doable till the enterprise proprietor’s partner attain age 65. At age 65, the likelihood exists to earnings break up along with your partner.
6) Active Business Income
A scenario the place a salary could present a profit is when the corporate is a Canadian Controlled Private Corporation (CCPC) incomes energetic enterprise earnings eligible for the small enterprise deduction.
This preferential tax therapy is at the moment restricted to the primary $500,000 of energetic enterprise earnings, which is taxed at a decreased price. Income above this threshold is taxed on the common company price. Paying a salary (or bonus) to scale back the corporate’s enterprise earnings to $500,000 could also be advantageous.
7) Level of Passive Income
For tax years beginning after 2018, there’s a new rule, generally known as the “passive earnings rule”, which is a straight-line discount to the small enterprise restrict for CCPCs when related firms earn adjusted combination funding earnings (AAII) of $50,000 or extra. AAII contains funding earnings and bills with sure changes.
The small enterprise restrict could be decreased by $5 for each $1 of AAII above the $50,000 threshold, such that the small enterprise restrict could be eradicated when AAII reaches $150,000 in a tax yr. Paying a salary could be a enterprise deduction which reduces the quantity of taxable enterprise earnings topic to the final price, which is increased than the small enterprise price.
8) Stability of Earnings, Flexibility and Simplicity
Some of our enterprise proprietor shoppers have fluctuating incomes. When a salary is paid all year long at a predetermined stage it’s not essentially reflective of the earnings generated. In truth, it could be materially totally different.
As famous above, if a enterprise is having a excessive-earnings yr, the enterprise proprietor ought to consider paying a salary to get earnings beneath the $500,000 threshold. This could be completed via a bonus, moderately than a month-to-month salary. This offers some flexibility and is usually considered as an easier strategy.
In different instances, if the company shouldn’t be having a superb yr, then funds of a major salary through the yr might lead to working losses.
Business Owner #1 has steady working earnings yearly and the cost of a salary is the most suitable choice.
Business Owner #2 has earnings that fluctuates significantly yearly and has chosen primarily to pay dividends.
9) Debt Financing
Many of the enterprise homeowners that we work with may even have private belongings equivalent to a principal residence. In some conditions, our shoppers would love to have a mortgage or debt to finance totally different alternatives that aren’t inside the company.
A key issue on whether or not to pay a salary or dividends is whether or not our enterprise proprietor shoppers will need to get hold of financing sooner or later for a personally owned asset(s).
In the method of making use of for debt or a mortgage, our shoppers should present their private tax returns as a part of the approval course of. A daily and constant salary is considered extra favourably than a fluctuating dividend cost. If our shoppers want to tackle further private debt for alternatives, then the cost of standard salaries is the most suitable choice.
10) Estate Planning
One of the items that we focus on with all our enterprise proprietor shoppers is the tax penalties of passing away with shares of a CCPC. In many instances after these discussions we map out an in depth plan that includes the cost of each a salary and a dividend. This is particularly true when earnings splitting alternatives can be found, and registered account carry-ahead room exists.
The choice to obtain earnings as dividends or salary ought to be made with assistance from a tax skilled and analyzed primarily based on every particular person’s scenario. Often, a mixture of the 2 proves efficient in benefiting from decrease efficient private tax charges on dividends whereas acquiring advantages from salary funds, equivalent to CPP and RRSP participation. Various components, equivalent to family earnings necessities, different sources of earnings for every partner and province of residence ought to be thought-about in deciding the optimum mixture of salary and dividends.
Kevin Greenard CPA CA FMA CFP CIM is a Portfolio Manager and Director, Wealth Management, with The Greenard Group at Scotia Wealth Management in Victoria. His column seems each week at timescolonist.com. Call 250-389-2138, electronic mail [email protected] or go to greenardgroup.com/secondopinion

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