How to get paid from your business – dividends, wages, or owner advances
A distinction that seems to be lost on a number of people with their own businesses, either new entrepreneurs or old, is how they get paid and the different tax benefits or costs to it. This article should be fairly old hat for anybody who has taken some tax courses but it seems to come up fairly often for everybody else. Please note this post is talking about corporations, not sole proprietors or partnerships. This is not going to cover other means like trust companies or other corporations.
Wages – wages are generally the highest tax rate to get money out of your business. However, one thing to keep in mind with this is that any wages taken from the company will reduce the corporate net income of the company, thereby lowering taxes that must be paid there. The other ramification of wages is that you have to calculate the source deduction payments, for example the income tax and the Canada Pension Plan (CPP). As an owner, the other thing to keep in mind is that the company is now responsible for the company portion of the CPP. Employment Insurance (EI) is not relevant for owners of the business because they are exempt. For example, if a company has $10 in net income before paying the owner, and they paid the owner $4, the company now has net income of $6. The company now gets taxed on only $6. The individual gets taxed themselves on $4 of income.
Dividends – dividends have a much lower rate of tax than wages. The key difference is that unlike wages, the company still pays tax on any dividends that are paid to shareholders. Therefore the lower tax that is paid personally is recovered by the corporation. In my tax course, they called this “integration” which is to prevent people and corporations from getting taxed twice. For example, following the same example as before if the company had net income of $10 in net income before paying the owner. This time they pay the owner in dividends the same $4, the company still has net income of $10 to the government. The company will be taxed for $10, and the individual will be taxed on $4 but at a much lower rate than if they were taken as wages before.
Owner advances – owner advances are only generated in a special way, but it’s a key concept. They are created by owners putting / investing into their own business. Whether that is assets like equipment, furniture or in the form of cash, all those transactions should be recorded very well. Every dollar put into the business can be taken out by the owner completely tax free. So for example, if an owner has put $10 in to the company, the owner can at any time take that $10 they put into the company without declaring any additional income at all.
Obviously, there are a number of different scenarios that are possible based on the income involved, or other factors that may pertain to the individual. You can also do some mixing and matching to find the best possible combination for you. This is just a very simplified scenario. If you have more specific questions, feel free to call or email me. Or talk to your own accountant and ask for some more clarification.
BDO – Owner manager considerations