Owner-Manager Remuneration
One of the primary benefits of incorporating a business is the ability to implement an optimal remuneration strategy. The corporate structure allows you to defer tax while determining the correct mix of salary and dividends each year depending on tax rates and your personal lifestyle. There are many factors that must be considered when determining the best strategy for you.
Salary is paid from pre-tax income and is deductible for corporation income tax purposes while dividends are paid from after-tax income and therefore are not deductible. Accordingly, corporate earnings that are paid out as a salary are only taxed at the personal level while earnings that are paid out as dividends are taxed at both the corporate and personal level. However, you are not subject to double tax as one of the fundamental concepts in our tax system is “integration”. At a high level, integration means that the combined corporate and personal income taxes on earnings paid out as a dividend should be the same as the personal taxes on a salary. In reality, perfect integration is next to impossible to achieve and there is either a tax cost or benefit to having earnings taxed at the corporate level. This creates opportunities to reassess your remuneration strategy each year depending on the cost or benefit.
Other key factors to assess are the type of income earned, the current year taxable income and income tax rate of both the corporation and the owner-manager. For active business income, corporations are subject to tax at a combined federal and provincial general rate of 23% to 31%. Canadian-controlled private corporations (CCPCs) may be eligible for the reduced combined small business rate of 9% to 13% on active business income up to $500,000. A common remuneration strategy is to pay salary or a year-end bonus to reduce corporation taxable income below the $500,000 threshold and avoid the general rate of tax. Bonuses accrued at year-end must be paid within 180 days to be deductible by the corporation.
CCPCs that earn passive income are subject to refundable taxes that accumulate in a Refundable Dividend Tax on Hand account. A refund of these taxes is only triggered when taxable dividends are paid to the shareholders. These taxes are recovered at a rate of 38 1/3% of the taxable dividends paid. Therefore, payment of taxable dividends should be considered to recover these amounts.
Combined personal tax rates can be as high as 54% at the top tax bracket for ordinary income which includes salary. You should assess your personal lifestyle and cash flow needs. It may be advisable to leave funds in the corporation and defer taxes to a later year. If you expect your personal income from other sources to decline in future years, you may be able to withdraw funds at that time and turn the tax deferral into tax savings.
Another key consideration is that salary allows the owner-manager to contribute to a Registered Retirement Savings Plan (RRSP) and the Canada Pension Plan (CPP). RRSP contribution room is only created through earned income which includes salary but not dividends. In 2020, you needed to earn $154,611 to create the maximum 2021 contribution room of $27,830. In 2021, you must earn maximum pensionable earnings for CPP of $61,600 to make the maximum contribution of $3,166.45. These amounts are indexed to inflation. Including salary in your remuneration strategy is necessary if you plan to utilize these pension plans during retirement.
If salaries or bonuses are paid, the corporation is required to deduct payroll taxes at source. This includes income tax deductions and CPP. Deductions for Employment Insurance are not required if the owner-manager owns at least 40% of the voting shares of the corporation, but the owner-manager can elect to pay EI premiums if they wish to gain access to benefits. The corporation will be required to pay the employer portion of CPP and EI premiums. There may be additional taxes and premiums as well depending on provincial regulations.
Determining a remuneration strategy has many moving parts and competing considerations. It is dependent on your personal plans and can change each year.
For more information, please contact info@gytdcpa.com or 1 844-GYTD-CPA
GYTDCPA.com-Owner-Manager Remuneration
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