Tag Archives: best practice

How to Pay Yourself

 

You run your own business and want to pay the least amount in taxes, so what’s the smart way to pay yourself? 

The goal is to keep the biggest slice of pie for yourself. The best way to do that depends on your business type, whether your business is a sole proprietorship or a corporation. 

Your Business Structure 

Sole Proprietor 

As a sole proprietor, you are your businessYou can’t be an employee of the business, which means you can’t draw a wage from your business. There’s no way to defer taxes by leaving money “in the business”. The business income and expenses are recorded as an additional schedule on your personal taxes, and all your income is taxed together. 

Having said that, I do recommend keeping the business money separate from your personal money. Make sure to open a business bank account to help with this separation (read this to find out why: https://www.kirkcpa.ca/do-you-need-a-business-bank-account/).  

How do you pay your personal expenses? Don’t do it from the business bank account. Transfer the money from your business account to your personal account and pay your personal expenses from there.  

*Pro tip, these transfers to your personal account don’t count as expenses for your business. 

Corporation 

Paying yourself from a corporation is little more complicated because it’s a separate legal entityI mean, logistically it’s the same in that you can transfer money from your business to your personal account, but the corporation will have to classify that payment as either dividends or salary (for the purposes of this explanation we’ll treat salaries and bonuses as the same thing).  

The biggest difference between the two methods is a salary is tax deductible for the corporation and dividends are paid out of after-tax income. 

What does that mean? 

A corporation is a separate legal entity from its owner(s) (known as shareholders). As a separate legal entity, the corporation is responsible for paying taxes on its income. If a salary is paid out to an employee, the corporation can deduct it from revenue before calculating taxes. 

The salary is then taxable for the individual. This bit isn’t news. Most of us have worked for someone else, where we’ve been paid a wage that we needed to pay taxes on. 

Paying a wage seems like the better option because you only pay tax once – on your personal taxes. Payroll has its downfalls though. It’s administratively more work because the corporation needs to deduct income taxes and CPP from the salary (just like if you worked for someone else), match the CPP contribution, and remit it to the CRA every month. It can also be more expensive because CPP isn’t paid on dividends, so if the CPP is more than the corporate tax bill it might not be worth it. 

Dividends 

Dividends are not tax deductible for the corporation, so the money paid out has already been taxed at the corporate level. You might be thinking “sweet, if tax has already been paid, does that mean it’s tax free for me to withdraw?” Nope, unfortunately not. You still need to pay personal tax on dividends, which means you’re effectively paying tax twice.  

So why would you take dividendsFor you as an individual, dividends are taxed at a lower rate than a salarySometimes paying tax at the corporate level (usually lower than paying at the individual level) plus paying the lower individual tax rate on dividends is actually less than the individual tax rate on a salary.  

Let’s recap 

Salary 

Dividends 

Tax deductible for the corporation 

Not tax deductible – paid out of after tax income 

Monthly remittances of income tax and CPP deductions 

No remittances 

Taxed at a higher rate for the individual 

Taxed at a lower rate for the individual 

Corporation has a portion of CPP to pay 

No CPP payments (which means no CPP withdrawal later in life) 

Increases your RRSP contribution room 

No impact on RRSP contribution room 

More conventional personal income so it’s easier to get personal loans 

Tougher to get personal loans (like mortgages) with only dividend income 

More formal process for getting money into the hands of the individual 

Simple transfer between bank accounts 

 

Which one should you choose? 

As with every question asked to an accountant – it depends. Your specific situation will determine the best way to pay yourself from a corporation. If you have another source of employment income, maybe dividends are the way to go. If the corporation is your only income, maybe you pay yourself a salary of $60k and switch to dividends after maxing out your CPP contributions for the year.  

To make the choice, it’s important to calculate the total tax (corporate and individual) payable for a few different scenarios to see which one is the best fit for you. If you’re doing these calculations on your own, I would revisit your strategy every year to ensure you always have the best fit for your changing situation. 

If you’d like help with this calculation, let’s chat! You can get in touch with me here: Contact

Kaitlin

For The Love of Taxes

This morning I went to drop off some tax papers to a client. She had some great questions, so I spent 40 minutes explaining how her tax return worked, and going over some of her previous year’s returns. She was trying to get an idea of how the various pieces of a year of her life could be summed up in a bunch of numbers grouped together on far too much paper.

She’s a very smart person, but was never taught how all this works, and that seems to be the case with most people.

That’s really sad. Partly because it’s a life skill we should all learn as teenagers, and partly because I love it and I want other people to experience the same joy when they do their taxes. Ok, maybe joy is pushing it, but if we strive for joy and land on something a little more positive than dread, that’s a win.

I like to think of taxes as that scary kid in class with the mohawk. The one that most kids were a little afraid of, but once you got to know them they weren’t so bad.

Love of Taxes: The Origin Story

When I was 15 my Dad showed me how to do my taxes. At the time we were doing them by hand, so I had my pencil and my calculator out, and we would go through every line. My return was very simple at that point because I only had one T4, but it was so fun. How could get as much back as possible? How can I play the government’s game and win? (without cheating though, ’cause I’m not in to that).

Then one day I was hanging out with my group of friends and I noticed one of them had “T4” written on his hand. I asked him “hey, are you doing your taxes?” He said I was the only person who knew what that meant. I jumped on the chance. “You want help?!”

By the time I was 16 I was doing all my friend’s taxes… by hand.

I don’t do them by hand anymore, but I’m still doing my friend’s taxes. Every now and again they’ll get a Notice of Assessment from the CRA (Canada Revenue Agency) asking for proof of expenses, like child care receipts for example, and it’s presumed the tax return was filed incorrectly until they see and approve those receipts. (The CRA doesn’t believe in innocent until proven guilty, you’re wrong until you can prove otherwise).

Surprise bills are never fun, but it seems to be so much worse when they come from the CRA. It feels like those bills are written in some kind of code, and you have no idea what they’re asking for. So frustrating.

These stress-inducing letters are exactly why I think we should starting learning about taxes as teenagers. Guess what though, it’s not too late to learn!

As adults we can learn how our taxes work, and remove the uncertainty and stress that comes with them. Even if we never want to actually prepare our own taxes, we can still have a better understanding of how it all works, and be able to have more informed discussions with our tax professionals.

This is especially true for sole proprietors. Our business taxes and our personal taxes are one and the same, so having an understanding of the system is part of doing business. How much should I set aside from every sale? What expenses can I deduct? Do I need to charge sales tax? How does that work?

As your business becomes more complex, so do your taxes.

The first step to reducing tax stress is to be organized with your paperwork, Don’t think of taxes as a once a year event, think of them as something you maintain. It’s like oral hygiene. If you only brush your teeth once a year, things are going to get gross.

The best results come from healthy tax habits like regular receipt management and bookkeeping.

Kaitlin

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The Burden of Incorporation

You have this amazing idea, you know you can help people, and you’re sick of your 9-5 job – so you make the choice to start your own business. It’s scary, but SO liberating.

Great! You’ve decided! You’re doing it! Yay!

Now what?

Should you incorporate? It would feel so official to incorporate. You’d have a real piece of paper saying you owned a company! You could take a selfie with it to keep as a record of this exciting new chapter in your life!

Let’s slow down. I totally understand this feeling. When I started my business, I wanted everyone to know. I was SO excited to go on an adventure and leave my old life behind.

An Incredible Journey

On your journey, you need the right tools. Think of your business form like a backpack. You want your pack to be the right size and weight for the adventure you’re on, so it doesn’t slow you down, but has everything you need in it.

If you’ve headed out for a day trip, maybe a small backpack that can hold your lunch and a couple water bottles is all you need. It would be nice and light, but would have everything you needed for the day.

What if you wanted to go on a multi-day trek up the side of a mountain? You’d want to have a big camping pack with a tent, a sleeping bag, a change of clothes, and a bunch of food and water.

Now think about having that big camping pack on your day trip. It would take far more energy to haul that pack around than the small backpack with just your lunch.

Business forms are the same. Think of the camping bag as a corporation. There are times when you absolutely want to have a big, heavy corporation for your business, but if the benefits of having all that structure is less than the weight of it, don’t incorporate.

There are a number of considerations when you’re deciding whether or not to incorporate your business, here are my top five:

Risk

A corporation is a distinct legal entity separated from you as a person. This arms-length distance can be especially important if you are working in an industry that is exposed to risk.

In the unfortunate event that your company is sued the assets of the company are at risk, but the lawsuit would not be able to touch your personal assets. At least in theory… in practice it is not uncommon for the business owner to also be personally named in a legal claim. (if you are concerned about your business liability, you should be consulting a lawyer to have this discussion)

Start-up Cash

If you need a bunch of money for start-up costs, a corporation will allow you to sell equity (shares) in the company or to take on debt to generate the funds you need. Except that a new corporation has the about same credit rating as a teenager who just moved out, so loans can be a challenge.

As a sole proprietor, you’re limited to your savings or the amount someone (like a bank or your Grandma) is willing to lend you.

Transferability

Are you in business for life, or planning to make fast money and a quick exit?

A sole proprietorship isn’t transferable. Somebody can buy your individual assets (like your equipment, website code, and rights to your trade name), but the business itself can’t be separated from the owner.

A corporation has shares, and shares can be transferred. It’s by selling shares that you’re able to sell a corporation
and everything that goes along with it. You can sell the assets of a company, but then you’re left with shares of a company with no assets, so that’s a whole other conversation.

Paying Yourself

As a sole-proprietor all your business income IS your personal income. Technically, there is no dividing line. (Though, for the sake of your sanity and success, I really recommend keeping very separate records for yourself and the business)

Your personal taxes and bookkeeping will become much more complicated than you may be used to as an employee.

When you incorporate, the tricky part is then actually paying yourself for your work. As an individual you’re taxed on any money you pull out of the corporation. That means for the corporation to be worth it, the total amount of taxes paid by yourself and the corporation needs to be less than if you paid tax on all of the income personally.

A corporation is a separate legal entity from yourself, which means you need to file a separate tax return. These are not easy returns, even if the company didn’t do much in the year. You’re going to need an accountant to prepare the taxes, and it won’t be cheap.

There are a few tax planning opportunities with a corporation, but if you’re not making a certain level of income, it doesn’t matter.

Flexibility

It’s a paperwork-intensive process to incorporate a company and it takes a little while. You have to file annual reports whether or not the corporation had any business activity. It also must be closed (which means still more paperwork) if you ever wanted to quit.

A sole proprietor on the other hand, can just start doing business (make sure you have the proper licenses) and can stop whenever they want to. There’s a lot more flexibility there, so if life gets in the way, no big deal!

My general recommendation is to start out as a sole proprietor and only incorporate when it becomes beneficial for you. This article is by no means an exhaustive list of reasons for or against incorporation. If you’d like to chat more about this, I’d be happy to help you out https://www.kirkcpa.ca/contact

When you start out on a business adventure, just grab the small backpack that’s already in your closet and head out the door. While you’re out, if you decide to take on a much longer and more complex adventure, you can always go by the camping store get yourself a bigger backpack with everything you need in it.

Kaitlin

P.S. If you’re on a business adventure come join us in the Captains Harbour community! We’re business captains that have come together to chat and get support on all things accounting and taxes!