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Paying Yourself: Salaries vs. Dividends – Part Two

The Pros and Cons of Salaries

Today’s blog is the second of a two part series on paying yourself as a Small Business Owner — should you pay yourself a salary or in dividends?

In part one of this two-part blog, I examined the benefits and drawbacks of compensating yourself with a salary; this second analysis will provide a breakdown of dividends. Click here to read part one!


So what are the ins-and-outs when, as a small business owner, you decide to pay yourself via dividend?  Here are some of the pro’s:

It’s simple: when you need money, just write yourself a cheque.  There are no source deductions to make and no reports to send to the government.

Lowest tax in the short term: with dividends, you do not pay into the Canadian Pension Plan (CPP). CPP contributions in 2017 are $2,564 for the employee and an additional $2,564 matched by your employer (i.e. your company), so your annual tax savings here is $5,128…a nice little weekend get away!

Depending on how you think about CPP, this can be a good thing or a bad thing. Generally speaking, if you don’t pay into the CPP program, you don’t get any pay outs once you retire. Some folks think that CPP won’t be around when they retire in 30 years, so they don’t want to pay into it.  Our opinion is that CPP is here to stay and provides a good safety net if your business unexpectedly fails.  Paying $5,128 per year into an investment portfolio for 45 years (the average working life of a person) and then being entitled to receive roughly $1,200 per month until you pass away is a very reasonable return on your investment.  Are you sure that you can do better than this investing the money yourself?  Not paying CCP premiums is the primary reason that the tax rate differs between salaries and dividends.  When CPP is ignored, the tax rate is nearly equivalent between salaries vs. dividends.

You can pay inactive persons: income splitting is a powerful tax management strategy.  Currently, you can pay shareholders (i.e. your spouse, your brother, anyone that owns shares in your company) a dividend even if they don’t provide any services to your company.  This allows you to direct income to lower income earning people and save a significant amount of tax.  Note, our liberal government is currently working to end this benefit.

Flexibility: we can easily change how much income we declare to you by having you repay any excess monies you withdrew from the company.  This can be helpful to manage your income tax rate in any given year.

There is always a downside. Here are some of the cons associated with dividends:

Surprise tax bills: depending on how much you withdraw from the company, you may have a tax bill the following April.  Your taxes could be as little as 0% or as high as 50%…it all depends on how much you withdraw.  MAKE SURE you talk with a qualified accountant before withdrawing more than $50,000 from your business.  Clients and accountants both hate surprise tax bills.

RRSP’s: you will not have access to the RRSP program.  RRSP’s are super important…in our opinion they are one of the best tax deductions available. We wrote a whole blog just on them for that reason (read it here).

Higher tax rate in the long term: generally speaking, you will end up paying more tax in the long run if you utilize dividends consistently over your lifetime, primarily due to the RRSP component described above. Please note that this depends on your personal tax circumstances and is not a universal truth.

Summing it all up, we generally take a mixed approach to the salary vs. dividend question.  This way we get the benefits from both salaries and dividends, while minimizing the downside.  While we would love to give you some specific instructions here, the “right” answer for you really depends on how much money you’re going to need over the long term from your business. Are you wondering what the best combination is for you? We offer everyone a free hour to discuss any questions that you may have. Contact us here.


Disclaimer: Tax and legal rules change frequently and can depend on your individual circumstances. The above is not to be relied upon as legal nor tax advice and is meant for information purposes only. Please consult a legal and/or tax professional.

Kent Greaves 1 Comment

Paying Yourself: Salaries vs. Dividends – Part One

The Pros and Cons of Salaries

Today’s blog is the first of a two part series on paying yourself as a Small Business Owner — should you pay yourself a salary or in dividends?

You’ve started your own business and you’re finally starting to make some money — your suppliers and staff are being paid, as well as your bills, which means it’s time to take some money out for yourself. So, is there a difference between the money you earned while working for someone else and the money you’ll earn working for yourself? Not really — but there is a difference in how you collect that money. Today we’re talking about the pros and cons of taking a salary as a small business owner.

In terms of how often you get paid, there is no difference at all! Set yourself up to receive a pay cheque as often as your other employees do (for simplicity’s sake) such as bi-weekly, monthly or perhaps quarterly.

When it comes to writing the cheque, what’s easier? With a salary, you will have to manage payroll, which can be time-consuming and for many small business owners, a little overwhelming. Talk to Kent Accounting about our Payroll Service Bundles and take one more thing off your to-do list. As for overall money management, when paying yourself is a part of your monthly rhythm, it’s a lot easier to control and monitor how much you’re spending and how often you’re taking money out, as opposed to those who take money out of their business ad hoc.

In the short-term, taking a salary will mean you will pay a slightly higher tax rate. You’ll pay CPP (Canadian Pension Plan) and income tax off of every cheque (generally speaking, business owners and their immediate family members are exempt from EI). As a small business owner, remember not to be late with remitting your source deductions to the CRA, as there are penalties every time you are late (10% the first time you’re late, 20% the second time you’re late).  To avoid remittance penalties, contact Kent Accounting and let us manage your payroll services and your source deductions.


However, salaries give you some great tax advantages in the long-term — namely, the right to receive a pension when you retire and access to RRSP room.

CPP: by contributing to CPP, you gain eligibility to receive CPP payments starting as early as age 60. While the payout amount varies from person to person, many Canadians over 60 years receive approximately $1,200 per month. CPP is a savings safety net that ensures all Canadians can have a comfortable retirement.

RRSP:  salary also allows you room to contribute to your RRSPs (up to 18% of your calculated total yearly salary) with a maximum, in 2016, of $26,010.  When you contribute to an RRSP, you get a refund on any tax paid on the income you earned.  Many of our clients receive 30% or more back for each $1 they contribute… so a $10,000 RRSP contribution could get you a $3,000 refund. That refund would pay for a nice vacation for you!

Note that the refund amount depends on your total income for the year. Further, investments in an RRSP grow tax-free. Not sure what that means in terms of dollars and cents? It’s such an important topic I wrote a separate blog about it (click here to read it). RRSPs are considered by many to be the best tax deduction available to Canadians.

There are some rigid rules to salaries that can’t be discounted. With salaries, you can only provide pay cheques to people who have provided services for your company, so your salary is yours alone. Also, once you’ve reported your total salary to the CRA, there’s almost no flexibility in changing how much you earned for any given year, and that lack of flexibility can be challenging for some.

We strongly encourage you to discuss your remuneration with a qualified small business accountant.  Want to talk to us about it?  Contact us here.

 


Disclaimer: Tax and legal rules change frequently and can depend on your individual circumstances. The above is not to be relied upon as legal nor tax advice and is meant for information purposes only. Please consult a legal and/or tax professional.

Kent Greaves 1 Comment

Understanding Your Personal Debt Load

Almost every Canadian household has some form of debt or another. And while taking on debt has become a part of Canadian life, it’s important to have a thorough understanding of your debt situation, and where it is taking you. Many of us have debt products thrown at us (every month I get blank cheques in the mail from credit card companies telling me to spend, spend, spend!) and knowing what to do takes education and discipline.

I like to keep things simple, in my mind there are two broad categories of debt – Good Debt and Bad Debt.


Good Debt: Includes a reasonable mortgage, investment debt and student loan debt. Of course, there are limits; here are some notes on each one:

  • Mortgage Debt: This should be less than 3X your annual salary. So if you/your family earn $100k per year, your max mortgage should be $300k. Note there are some minor exceptions here, but this is the rule of thumb I follow myself.
  • Investment Debt: Borrowing money for stable investments, especially when invested in an RRSP, can make a lot of sense. Note that you should be paying this loan back by the end of the current year.
  • Student Loan Debt: Borrowing for your education is good, provided the program has employment potential and you can pay off the amount borrowed in roughly 5 years.

Bad Debt: We all know when we are spending above our means…if you can’t buy it with cash, should you really be buying it at all? Bad debt includes the following:

  • Consumer Debt: T.V.s, vacations, clothes, kids’ toys, and any other item that is not a necessity (i.e. food, shelter or water).
  • Too Much Mortgage Debt: Any mortgage over 3X your annual salary is leaving you very exposed to interest rate changes. I know several people with an $800k or higher mortgage… If interest rates go to 6%, it literally doubles the required monthly payment. Can you afford your mortgage to double? I will be doing a separate blog on interest rates in the coming weeks.
  • Frivolous Student Loan Debt: If you are uncertain your education will get you a job, do not borrow money to fund it. Now, I am not saying a Fine Arts Degree isn’t a good education, but I am saying don’t borrow money to do it. I have met countless 30-somethings still paying off an education they didn’t really want/didn’t really use and, of course, they now wish they never went to school. Universities and colleges are in the business of graduating students and not necessarily in the business of helping you get gainful employment.

Our current spending culture is a “now” culture — we want instant gratification to satisfy our cravings. This impulsive and unprepared spending can lead to bankruptcy, especially if you are faced with a sudden change in income. Being disciplined is hard (I struggle with it from time to time as well!).

When reviewing your debt, here are a few things to ask yourself:

  • How much do you annually spend on interest? Take a deep breath, sit down and add it up. If you pay more than $10,000 of annual interest, that is an absolute sign that you have acquired too much debt. Imagine what you could do with another $10,000 of cash?
  • Are you paying your credit card bill off entirely, every month? If not, then why are you spending more than you earn? That is a good sign that you are acquiring too much material debt.
  • Keeping track of your net worth year over year can also give you an idea of your debt. Your net worth is your assets, less liabilities — year over year. Is your net worth getting bigger or smaller?

Those are all ways to give yourself a quick and healthy self-review of your debt so that you can better take control of your debt and, ultimately, your financial future. Interests rates usually only go one way — up. A 1% change in interest rates can create a significant bump in your monthly payments, as outlined in the chart below.

$500k mortgage, 25 years at 3% = $2,366 monthly payment

$500k mortgage, 25 years at 4% = $2,630 monthly payment

$500k mortgage, 25 years at 5% = $2,908 monthly payment

Could you handle a $300 – $600 increase in your mortgage overnight? Canada is a country that has been spoiled by low interest rates for more than a decade. Many experts are predicting an interest rate bump of 2% within in the coming years. You need to have a financial plan that clearly shows what your income, expense, investment and debt horizons look like so that you can determine if your spending is taking you down a path that is unwise.

It is critically important that you gain a handle on when you will become debt free. Entering retirement age with any debt will significantly limit your ability to have a comfortable retirement. In my opinion, a healthy retirement starts with roughly $2,000,000 in an investment account and no debts at all. Of course, there are always exceptions; give me a call and we can discuss your personal situation.


Disclaimer: Tax and legal rules change frequently and can depend on your individual circumstances. The above is not to be relied upon as legal nor tax advice and is meant for information purposes only. Please consult a legal and/or tax professional.

Kent Greaves 6 Comments

Using RRSP’s and TFSA’s as Long-Term Savings Options

What opportunities do Canadians have to make their extra money go the furthest for them? Saving for the future is one of the best decisions an individual can make, but there is more than one way to make your money work for you. When investing in the stock market, there are countless ways to do this; in this article, we will discuss the three most common ways to hold stocks: Registered Retirement Savings Plan (RRSP), Tax Free Savings Account (TFSA), and an unregistered account (sometimes called an “Open” account).


At Kent Accounting, when we talk to clients about how to maximize their money, we often talk about TFSA’s and RRSP’s, as well as Open accounts.  In the opinion of Kent Accounting, the strongest tax deduction available for Canadians is through investing in an RRSP.  RRSP’s provide immediate tax relief, continued tax-free growth, as well as peace of mind and financial security for the future.  Like many Canadians, you may not realize that the largest expenditure you will make in your life is not real estate investments, but in fact, your taxes. There are a number of types of savings accounts that can help alleviate your yearly tax bill and help you save for retirement, and today we’ll be exploring two of the most popular.

One of the most common and well-known savings opportunities is a Registered Retirement Savings Plans (RRSP). For every dollar that you contribute to an RRSP, the government will credit you at the highest tax rate you are currently paying. For example, at a salary of $70,000 per year, you would receive $305 back for every $1,000 RRSP contribution you make, making RRSP contributions a great way to manage the amount of tax you will be paying. Note that the refund amount fluctuates as you contribute more/less or earn more/less, so be sure to discuss this with your small business accountant.

The Government of Canada provides you with RRSP room equal to 18% of your earned income each year.  In 2016, the maximum an individual could contribute to an RRSP was $26,010. If in years past, savings goals have lead you to put your money elsewhere, not to worry – any unused RRSP room from previous years is rolled over and accumulated, meaning you might have more opportunity to invest in your RRSP’s than you realize.

There are some drawbacks with RRSP’s that are important to consider. While you do not pay any tax on the growth of RRSP’s, you do pay tax on withdrawals, and from a tax perspective, it is far wiser to withdraw from your RRSP during your low-income years (retirement). When you withdraw from your RRSP, not only are you taxed, but you also lose any accumulated “room” in your total investment pool, meaning you cannot replace those monies in the future.

At 71, all Canadians must convert their RRSP’s to Registered Retirement Income Funds, which provide you with yearly income. Here’s an example of what your retirement plan could look like if you take advantage of your RRSP opportunities.

If at age 35, you begin to contribute $5,000 a year to your RRSP, by your 71st birthday, you would have $1,070,259 (assuming 7% rate of return and all tax refunds reinvested). If you invested in a regular investment account, on your 71st birthday, this same yearly investment would amount to $509,195 (assuming the same rate of return as the RRSP). That is $561,064 more in your RRSP account, which is more than double the return on investment.

Roughly half of Canadians do not contribute to their RRSP’s, which is a huge missed opportunity, both regarding the ability to save for a happy and fiscally healthy retirement and the opportunity for yearly tax savings over the course of your life.

RRSP’s are a great way to save, but they aren’t your only option. A Tax Free Savings Account (TFSA) is an account that has a set amount of room per year (in 2017, that set amount is $5,500, but year over year, that amount does fluctuate). While unlike an RRSP, you do not receive any tax deductions when contributing, you are not taxed on the growth of your investment, and you have the flexibility to contribute and withdraw at any time.

Using the same savings example as above, let’s look at how contributing to a TFSA as a retirement savings plan can benefit you.

If you invest $5,000 per year from your 35th birthday until your 71st birthday, you will have saved $829,752 (assuming 7% rate of return), whereas in a regular investment account on your 71st birthday you would have $509,195 (assuming the same rate of return as the TFSA). Contributing to a TFSA account allows your savings to earn you an additional $320,557.

Regarding withdrawing funds over the course of your life, you do have that flexibility, and you do not lose the accumulated room to contribute to your TFSA account – if you withdraw, you simply have a set amount of time to put the funds back.


So how can you decide which account is right for you? Determining your primary objective or goal for your savings will often point you in the right direction.

If your goal is to save on your yearly taxes and save for your retirement, then maxing out your annual RRSPs is likely the best course of action. If you have the opportunity to borrow funds to max out those dollars, it can be worth it. Contact Kent Accounting to discuss your best borrowing opportunities to maximize your RRSP’s.

If your goal is to save, but you’d still like to access your funds with plans to put the money back into the account, then opt for a TFSA. Call Kent Accounting to discuss your potential losses and gains in choosing a TFSA over an RRSP.

If you have something specific in mind that you are saving for, opting for a TFSA over an RRSP is a stronger choice, as you will not lose room in your accumulated pool of funds when you withdraw those monies and you also won’t be taxed on those withdrawals. There are two exceptions to this, as the Home Buyers Plan allows first-time home buyers to withdraw funds from their RRSP for a down payment on a property and the Life Long Learning Plan allows you to withdraw funds for educational opportunities.

At Kent Accounting, we have found that families who properly plan and save for retirement max out their RRSP savings year after year, as opposed to not planning and “hoping for the best.” Contact Kent Accounting for help devising a detailed and fruitful retirement savings plan.


Disclaimer: tax rules change frequently and can depend on your individual circumstances.  The above is not to be relied upon as tax advice and is meant for information purposes only.  Please consult a tax professional.

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Terms to Understand and Strategies to Help Small Business Avoid Bankruptcy

When people start companies, no one sets out with the idea in mind that eventually they’ll go bankrupt. Bankruptcy is often a combination of unforeseen circumstances and a lack of professional advice – one of the main reasons that a company goes bankrupt is because they run out of operating cash to pay their monthly expenses, and stop paying their bills. When you have a reliable and knowledgeable accountant on your team, avoiding bankruptcy becomes a part of your strategic plan from the beginning. Here at Kent Accounting we’ve provided some of the terms that are important for every business owner to know regarding bankruptcy and some starter strategies you can implement to help you avoid it!


Creditors

Formally, bankruptcy is what happens when a business is unable to pay creditors (those parties whom have lent the company money) and those creditors choose to take legal action by suing the company for the money that is owed.

Assets

When a company goes bankrupt, the first step is to sell off all the assets of the business. This can happen in many ways, but is usually done using a court appointed trustee, who oversees the sales process, and the proceeds are then distributed amongst the creditors by the trustee.

Profit versus Cash

The terms “profit” and “cash” are not interchangeable. If a company earns $10,000 in revenue in a month, and has $8,000 in wages and other bills in that month, then they earn a profit of $2,000.  However, as we all know, our clients like to pay us after 30 days (or more), but our employees usually want to get paid after one or two weeks.  The cash flow for the month will depend on how much money was collected from prior months’ sales in the month and it could turn out that the business may actually lose cash in the month, despite earning a profit.

Kent Greaves, CPA, CA of Kent Accounting, gives us this example to help explain how small businesses can find themselves overwhelmed by their profit versus cash situation:

“Take for example getting a big order or project that starts on January 1 and you estimate that order will take a year to complete.  Your initial cash outlay (for payroll and materials) would likely be in January with continuing cash outlays each month for additional payroll/materials.  If the project completes in December, normal payment in Alberta would be 30 – 90 days, with some larger companies taking as long as 6 months to pay.  This puts 18 months from your first cash outlay to receipt of all of the cash related to the project.  It is imperative that you map out the cash outlays your project will incur and incorporate progress payments into your negotiations with the prospective client.”


So what goes hand in hand with small businesses taking on larger projects? Running into cash flow problems, which can lead your company directly to bankruptcy. Here are just a few suggestions on how to avoid cash flow problems:

  • Project Size: When you are pitching to larger companies or responding to requests for proposals, ensure that your company is in a position to take on the additional work load. When considering, take into account labour costs, materials, and especially the drain on cash flow. Working closely with your small business accountant on these proposals will ensure you can deliver what you are promising. Unsure about how much more work your small business can handle? Contact Kent Accounting so we can help you accurately understand your capacity.
  • Cash Flow Forecast: With your accountant, build out a basic Cash Flow Forecast, which is a simple spreadsheet that lays out your estimated incomes and expenses for the year. This will enable you to understand the big picture of your business, and what kind of resources would be required on monthly basis to take on more projects and grow your business. BONUS: Download our Kent Accounting’s basic Cash Flow Forecast excel sheet to get started. Have questions? Don’t hesitate to reach out to our team.
  • Contracts: Set up a contract (a written one!) for every project over a certain dollar amount (e.g. $1,000). There are many contract templates available and your small business accountant can help you tailor those templates to ensure your business is protected from a financial standpoint. Contact Kent Accounting to review your current standard contract template.
  • Payment Terms: One thing smart small business accountants do is help business owners set up appropriate payment terms. An example of standard terms could be requesting 25% of payment up front, 25% half way through the project, 25% when the project nears completion and 25% upon client acceptance of finished product. Every business is unique and it’s best to consult with a small business accountant to make sure the payment terms you’ve set up are appropriate for your business and industry – contact Kent Accounting today for advice on payment terms.
  • Credit Policy: Simply put, a credit policy is a defined time-period for payment of goods and services and it is something many small businesses overlook when they are setting up their company. In the early stages of every business, finding a balance between generating new business and ensuring you do work with companies that will pay you promptly is critical. While setting up a Credit Policy isn’t difficult, what can be difficult is enforcing it. There will always be exceptions to your policy, but if you ask and expect your clients to abide by your policy, then you significantly reduce your risk of low cash flow and bankruptcy. To ensure your credit policy is thorough enough to get you paid, contact Kent Accounting.

Connecting with an accountant who specializes in small business is the first step to protecting your business from cash flow problems and bankruptcy. For a review of your current policies, don’t hesitate to connect with Kent Accounting.


Disclaimer: tax rules change frequently and can depend on your individual circumstances.  The above is not to be relied upon as tax advice and is meant for information purposes only.  Please consult a tax professional.