Paying youself

[north5995]

Hi guys,

My friend and I just incorporated our business. We are trying to figure out what is the best way to pay ourselves. As this thing is just getting going I don't think we will be paying ourselves much but nevertheless... we thought about paying outselves a quartlerly wage but then we'll run into having to remit income taxes, WSB, EI, CPP, etc from the business correct? Since we own all the shares we could pay ourselves a dividend but I don't want to be double taxed, I'd prefer something that'll lower our NI.

I searched but didn't come up with any good hits.

How are you guys doing it?

Thanks.

Edit - I can't spell and can't change the title of this thread.

[grant]

Dividends get preferential tax treatment as does active corporation income taxes. Theoretically the net payout from salary & dividends should be nearly equal.

Make sure you repay your shareholder loans first of course, which are "tax free"

If you don't want dividends & you don't want salaries.. then your final option is to retain the profits inside the corporation as shareholder's equity, and then sell the corporation to someone. As long as your business has been running for 2 years, your capital gains are tax exempt to a lifetime limit of $500,000.

Not sure why someone would pay you $1 for $1 locked up in a corporation though, so i dunno how feasible that is.

[Just Confused]

I'm an incorporated one man consulting company and I use dividends exclusively. With no employee payroll, I avoid any CPP, submissions to CRA etc. During the course of the year I write company cheques whenever I need money. I make them payable to my wife and me like "John & Jane Doe". At the end of the year my accountant adds up all my withdrawals, subtracts all my business expenses and then plays with the remianing number to see how much my wife gets as her dividend and how much dividend is for me (we both have a separate Class of shares) It depends on how much we make during the year from other sources.

[north5995]

Interesting. So how are your owner withdrawls treated? They are still taxed as income on your personal income taxes correct?

[Just Confused]

Yes, I'm still taxed on them. They're still dividends (just from a small business) so after all the expenses are deducted, and it gets split beteween my wife and me, the amount that lands in our pockets is still taxed personally. However, it is taxed under the preferential treatment for dividends, which is better than earned income but not quite as good as capital gains.

I am careful to use the word "Draw" whenever I record my payment cheques in my bookeeping. So it will be clear to any auditor that the withdrawal is clearly against future dividends to be defined at the end of the fiscal year. I've not been audited yet, however, I've only been running this business for 5 years.

In my mind, those are the 2 key benefits of incorporating over a sole proprietorship. I get to split my income with my wife, and then it gets treated as a dividend rather than earned income.

I actually have an adult daughter in university that I also pay her dividends on her class of shares to cover her tuition. So I split it 3 ways, but then that's just a circumstance of mine. You didn't mention if you have wives or husbands with whom you can split your income. That depends on how much you trust them... divorce is rampant. And did you give them a class of shares when you set up the corporation. If your business is wildly successful they will be entitled to a piece of the action anyway. But I suppose you could afford lawyers then and I'd read about in the papers <:-)).

Both sole proprietors and corporations get to deduct business expenses. For my consulting business, it averages about a quarter to a third of my gross revenue. This is the part where creative accountants can help. They can identify what is deductible as an expense (meaning tax free!). Check out a PHSP to make your medical expenses deductible. There is another thread here at RFD about them. I use www.brockhealth.ca

The downside is that I have no earned income to use for an RRSP calculation, and if I had to borrow money from a bank they would say I'm destitute and turn me down.

You mentioned EI when you opened this thread.... as owners of the company you are exempt from paying into EI because... you can never claim EI from this venture. You can't lay yourself off and collect it. The government saw that one coming a long time ago <:-))

As for WCB, you may be exempt there too depending on what industry you're in. Have a look at the rules before somebody tells you to pay for it. I'm in Alberta where IT consultants are exempt and I still have clients that want me to get it. Have a copy of the legislation handy with any exempt industry lists for your proivince.

You only pay into CPP if you set up an employee payroll for yourselves, but you will have to pay twice!! Once to pay the "company" share and once to pay the "employee" share. Another advantage for dividends method! However, I would say as much as everybody complains about government programs, a regular $800 or so per month for life after 65 is looking good to me (no pension in my little company). My CPP is languishing bacause I haven't paid into it for 5 years. It's been suggested we go back to a regular job before we retire so we top up CPP in the last 5 years before retirement. If you're young it probably isn't an issue.

Lots of things to think about... but thats why you started a business! The boss gets to solve all the problems. Good luck in your venture.

[north5995]

Thanks very much for that post... cleared a lot of things up!

[wheel]

Well, I'll be darn diddly doodled. I think that Just Confused's explanation is pretty much what our accountant has us do. I don't pay much attention to it, but that all sounds about right. The CPP thing is for sure the case (don't pay it) and the RRSP thing is also true. The accountant asked me if I cared about RRSP's - I don't really. I have some money in them, but I expect to have other assets that will eventually let me retire; and my money's better off invested elsewhere right now...like back into my own businesses.

[Bullseye]

Great info from Just Confused, and I can confirm it as accurate.

[iamhuman]

Great posts Just Confused. You've answered almost all the questions I have. Glad I found this thread. Cheers.