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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 2 Comments

What is Tax Planning?

Tax Planning is far more than just saving up for your taxes, or keeping your fingers crossed you’ll receive a tax refund so you can buy that coveted something. Tax Planning is about being fiscally strategic, and using the rules in the Income Tax Act to pay the least amount of tax possible while maintaining compliance with the law. For most people, the single largest expenditure in their life will be income tax. Take for example a person earning $125,000 per year. Based on 2016’s tax rates and some reasonable assumptions, they would pay $33,962 of tax in one year.  Take that over a working career of 30 years, and that’s $1,018,860 of personal income taxes…yikes! Proper (and legal!) tax planning can significantly reduce the amount of tax you pay.


Diving into tax planning takes knowledge and organization – the overall goal is to manage your effective rate of tax, and to keep that rate as low as possible. We have created a chart to help you understand where your effective rate of tax currently sits to give you a baseline to work from. Using the chart, find your income in the column called “Personal Income – Wages” and see what your effective rate of tax is (the column on the far right). A healthy tax plan has an effective rate of tax around 20%.

To improve your effective rate of tax, at Kent Accounting & Tax, we start by using the basic concept to defer, deduct and divide income where possible.

Defer: Do you have the ability to defer income so that it is earned over many years, as opposed to in a single year?

Deduct: Have you been using all of your deduction opportunities, like RRSP’s, capital gain exemptions, small business deductions or others?

Divide: Have you considered dividing your income between trustworthy family members (for example, if you earn $200,000 a year in your small business, can you share that income between yourself and your spouse, so that you both make $100,000 a year and have lower overall taxes?)

At Kent Accounting, we ask questions that lead to solutions – contact us today for more advice on how to optimize your tax planning opportunities.

While there are many straight forward tax planning opportunities, it’s not as easy as shifting figures from one column to another. The law on tax planning is complex and difficult to understand Make sure you’re making the right moves for tax planning – book a consultation with Kent Accounting.

You may think that you have followed the letter of the law when creating your tax plan, but even the CRA can get confused. Even more frustrating is that the CRA rules change on an annual basis, and as accountants, it’s our job to stay educated and up to date on changes. Incorrectly assessed taxes can lead to issues with your tax planning, making it even more important to work with a qualified accountant. Let Kent Accounting take care of the minutia of tax planning.

The more time you invest in building a strong tax planning strategy, the lower your effective tax rate can be and the more you can save.  If you pay 20% tax instead of 25% tax over the term of your career, the amount of money left on the table is staggering. If you were to save $25,000 per year, from age 35 to 55, and invest those savings at 6%, you would have $974,818 of extra money to spend in retirement. To get started on your Tax Planning Strategy, contact Kent Accounting & Tax today.

 


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.

Kent Greaves 1 Comment

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.

Kent Greaves 1 Comment

Smart Tax Deductions for Small Business Owners

Getting the most out of your business tax deductions requires more than just the diligent tracking and filing of your expenses – to maximize your business returns, you need to know what you can and can’t claim come tax time. However, understanding what components of your business qualify for a tax deduction can be a challenge for many owners – you are busy enough as it is running your business. Prioritizing and tracking the expenses you can claim can fall to the wayside. Kent Accounting has put together a simple list of the best tax deductions for you to record and claim to make the most of your yearly tax return.


Client Hospitality

Building strong relationships are essential to business, and the Canada Revenue Agency understands this. When you host your clients and take them to events, you can claim that for a tax deduction. Relationships can grow stronger when there’s a connection, so why not use that tax break to your advantage and treat your clients by taking them to events you enjoy. These events give your customers a chance to get to know you better as a person, and allow you to receive a tax deduction for doing fun things you will enjoy! How much on the dollar will you get back? Connect with Kent Accounting to find out.

Rewarding Your Employees

The hard work and dedication of your staff should be rewarded, and the Canada Revenue Agency knows this as well. So how can you build loyalty with your employees? Taking them out for exciting and unique team building events benefits small business owners, as job satisfaction levels increase, but it is also a claimable expense. To receive a tax deduction for employee parties and outings, all employees must be invited to attend so make sure to pick a variation of events and themes throughout the year that all your employees can take part in. How much on the dollar will you get back? Connect with Kent Accounting to find out.

Vehicle Mileage

Whether you drive a little for your work, or a lot, claiming your vehicle mileage is simple. In fiscal 2017, for every kilometer you drive, the company can reimburse you, tax free, for 54 cents per kilometer for the first 5,000 kilometers (i.e. if you drive a personally owned vehicle 1,000 KM’s for business purposes you can receive $540 tax free from the company). Depending on the vehicle you drive, the actual cost of driving is closer to 20 cents per kilometer, so tracking and recording your mileage can add up to extra money that’s tax-free. To regularly track your distance, consider an app for your smartphone or go the old fashion route by printing out a simple spreadsheet to keep in your glovebox. Does your commute qualify as vehicle mileage? Connect with Kent Accounting to find out.

Company Owned Vehicle

If your vehicle needs an upgrade, then leasing it as a company owned vehicle will allow you to claim up to $800 a month in fiscal 2017 for the cost of that lease. You are allowed to use a company owned vehicle for personal purposes, but you do pay personal tax via a taxable benefit at year end. Make sure you fully understand claiming your Company Owned Vehicle – contact Kent Accounting here.

Home Office

Claiming your home office on your taxes opens up deduction possibilities, such as mortgage interest, insurance, property taxes and utilities, to name a few. There are rules on how much time you must spend working in your home office to allow you to claim it on your taxes, so consulting with an expert Calgary small business accountant will allow you to make the most accurate tax filing.  Connect with Kent Accounting for help calculating the percentages of your bills that you can claim on your taxes.

Investing In Canadian Privately Held Companies

Investing in a Canadian small to medium business is not just good for your taxes, it is good for the economy, and it is good for your fellow business owners. There are many great advantages to starting your own small business, here are two of them:

Benefit 1: in fiscal 2017, when you earn income in a privately held company, you only pay 13% tax on those earnings.  This allows you to invest 87% of your money in new business ventures or the stock market. As an employee of a company, depending on the tax bracket you are in, many pay 35% tax which would only allow them to invest 65% of their money.  There is a substantial difference in investment potential.

Benefit 2: in fiscal 2017, if you sold a business for $824,176, you would pay zero in tax (note there are several restrictions on the type of business that qualifies).  This is one of the strongest tax deductions that are available to you as a Canadian resident and should be carefully considered as you plan your career.  The Canadian government provides this tax benefit as an incentive to you to start your own business.

To get a better idea of how to invest your funds in a Canadian privately held company, contact Kent Accounting today.


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.