Reminder to owner-managed incorporated businesses with Dec. 31 year-end… time is running out to determine treatment of any excess profits earned in the corporation in 2016.
As an owner-manager, you have a choice of:
- paying out the excess profits as a year-end bonus;
- distribute a portion of the profits as a dividend in the current year; or
- keeping the excess profits inside the company to be distributed as a dividend at some future date.
If you decide to pay out salary or bonus compensation, your corporation claims a deduction against its income for the amount of salary or bonus taken out of the company and you will pay personal tax on that T4 income received.
Alternatively, if you decide to take dividend compensation, your company will pay corporate tax on the income earned and you will pay personal tax when proceeds are distributed as a dividend.
The below table summarizes the key differences between receiving salary versus receiving a dividend.
|Considered earned income and allows for an individual to make RRSP contributions which can reduce tax in current year||X|
|Lower personal tax rate||X|
|Paying into CPP (both employee and employer portion)||X|
|Tax deduction for the corporation||X|
|Allows more personal income tax deductions (i.e. child care expenses)||X|
|Carry-back that portion income to utilize prior year corporate losses||X|
|Administrative convenience – less paperwork||X|
Based on the considerations discussed, it is apparent that the compensation strategy used in an owner-managed corporation is highly dependent on personal preferences and circumstances. What is your income level? What are your cash flow needs? What is the corporation’s predicted income for the year? Is RRSP room or other personal income tax deductions important to you?
The best option for you may even be a combination of both strategies. Consider paying yourself a salary large enough to make maximum CPP and RRSP contributions and taking the remaining portion as dividends. Speaking with a professional advisor can help you evaluate what strategy is right for you and identify any tax saving opportunities that may exist.