How Should Vancouver-based Business Owners Go About Paying Themselves?

Tax Tip for Business Owners

Here is a good tax tip that greatly benefits young entrepreneurs and businesses trying to survive the effects of the current recession:

If you are the owner of an incorporated business, there are two ways to pay yourself – wages and dividends.

Why are dividends the better way to pay yourself?

Most of us are very comfortable receiving pay because even prior to becoming an entrepreneur, we have had summer jobs where we received a pay cheque and even made RRSP contributions.

The problem with paying yourself a wage is that it is expensive because CRA imposes payroll taxes such as CPP and EI.

If you own more than 40% of the company, you can avoid EI on your payroll; however, CPP cannot be avoided. CPP is very expensive. Since you own the company, the combined CPP premiums are at 9.9% of gross wages, maxing out at $46,300.

In other words, if you pay yourself $50,000 in wages, the CPP premium alone costs you and your company $4,236.  The income taxes on the $50,000 would be $8,452.  So a $50,000 pay resulted in $12,688 taxes in total.

However, if you received a $50,000 dividend from the company, CPP does not apply to dividends, so there is $4,236 in savings right away. And $50,000 in dividends only triggers $1,788 in income taxes. Dividends paid are also not a business expense and therefore not deductible. Dividends are paid out of retained earnings, which are after-tax. Remember though that the corporate tax rate is 13.5% on the first $400,000 in profits British Columbia.

Dividends work really well for young entrepreneurs who are trying to accumulate funds to finance the expansion of the business. Young entrepreneurs in theory also have less personal expenses to pay, so in theory they shouldn’t need to extract a lot of funds out of the company for personal use

For business owners in Canada who are trying to survive the current recession, going the dividends route can result in smoother cash management. If a married couple both work in the business, the couple and the company save $8,472 in CPP premiums with this strategy alone.

The other advantage of dividends is that the CRA does not require monthly tax remittance on dividends paid to owners; payroll requires payroll withholdings remitted to CRA by the 15th of the following month.

My experience has been that once a business owner gets into the habit of issuing dividends for tax planning and income splitting purposes, the benefits will be obvious.

If you have any questions or would like to know how we can help you more, contact us.

Disclaimer: All Rights Reserved for Mew & Company. This blog post is designed to provide information for personal use only. Please consult your professional tax advisor for further information. Mew & Company is not responsible for any legal disputes resulting form the content of this blog post.