If you have a small business corporation, you may be receiving income in the form of salary or dividends. However, there are other ways of getting money out of a private corporation that may be more tax efficient. Here is a list of the seven most common ways to get money out of your corporation.
1. Salary
If you are an owner/manager, you can pay yourself a salary. The salary is taxable in your hands at your marginal tax rate, but it is deductible by the corporation. This may not seem to make sense: Why would you chose to pay tax at the higher personal rates rather than the small business rates? You should pay yourself enough to generate the maximum RRSP contribution room. Even if you don’t intend to use the RRSP room now, this may be beneficial in later years if you want to make RRSP contributions or if the business wants to establish an individual pension plan or IPP.
In addition, you will also pay into the Canada Pension Plan that allows you to draw on those benefits at retirement.
2. Bonus
If your corporations’ income is more than $500,000 or if your company’s earnings are volatile you might want to pay yourself a bonus instead of a salary. The bonus is treated the same as employment income for tax purposes but provides more flexibility in payment.
The bonus may also be used to bring the corporations income below the $500,000 small business deduction limit to maximize the use of the lower tax rates on corporate income.
3. Dividends
Dividends are paid from the corporations after tax-income. For most Canadian small business corporations, the dividends paid are ineligible dividends and subject to a 25% gross up and a 13.33% tax credit on the grossed up amount. This gross-up and tax credit system is designed to eliminate double taxation.
4. Payments on Loans From Shareholders
You can invest in a corporation through investments in shares or by lending the company (or any combination). If you lent money to the corporation, the repayment of the principal amount is tax-free.
5. Capital Dividends
Canada only taxes 1/2 of capital gains. When a corporation realizes capital gains, the non-taxable half of the gain is credited to a notional Capital Dividend Account. The balance of the capital dividend account may be paid to the shareholders entirely tax-free.
6. Repayment of Capital
The amount you originally invested in your corporation is credited to an account called paid up capital. The balance of this account can be repaid at any time tax-free. Keep in mind, that doing so may have other tax consequences later on, so speak with your accountant.
7. Loans To Shareholders
I have written about the concept of shareholder loans in the past. If structured correctly you may be able to extract funds temporarily from your corporation.
Other Methods
These are the primary way to get money out of a private corporation and is not a comprehensive list. If you have other methods of extracting money from a corporation, please share them by leaving a comment.
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The shareholder of a corporation may pay him or herself a car allowance for the business use of his or her personal vehicle. Currently the rates given by the CRA are $0.52/km for the first 5000km and $0.46/km thereafter. The result is an expense to the corporation and the shareholder receives the money tax free.
@Allan – Good one. Thanks
If you are an owner-manager and have a company owned automobile, consider paying yourself a tax free automobile allowance. This is an excellent way to extract money from your corporation tax-free.
The Canada Revenue Agency (CRA) allows a corporation to pay a tax-free automobile allowance to the owner of the vehicle at a rate of 52 cents for each KM driven for the first 5,000 KM and 46 cents thereafter. The amount paid must be based on KM’s driven for business use.
In addition to being tax-free to the recipient, the automobile allowance is tax-deductible to the corporation.
About the Author
Allan Madan is a Chartered Accountant in Mississauga and Toronto helping individuals and business owners with tax and accounting matters.
I will just add that income splitting is also an option, though it is partially covered by the categories you listed (dividend, salary…etc.)
I’m still looking into this but I believe if the corporation sets up an employee profit sharing plan, the employer is able to pay the employee earnings and is not required to pay CPP or EI for the ER side. Also, if the profit sharing plan is set up for RRSP purposes then the distributions that come out of it is also tax free to the employee.
@Belinda,
A group RRSP profit sharing plan is a DPSP (deferred profit sharing plan) and is not subject to CPP or EI premiums.
Can these 7 methods be used in combination or must one be “topped-up” before the other.
E.g. Do you have to pay dividends up to 100% of net income BEFORE repaying any amount of a loan payable to shareholder or return of capital or you can mix it up?
Alex,
You can do them in any order. Although, the company may be obligated to pay debts before dividends.
One thing owners of corporations should consider is the mix between salary and dividends. The dividend tax credit does provide a relatively generous tax advantage and can reduce personal taxes to very low rate up to around $40,000.
Paying yourself all dividends can cripple you in the long term: Dividends are not earned income and
a) Cannot be used to generate RRSP contribution room and will reduce your ability to use an Individual Pension Plan in the future.
b) Do not allow you to make a Canada Pension Plan contribution and may reduce your future CPP benefit. I would normally suggest paying a salary up to the current CPP limit at the very least.
c) If you have child care expenses, you will not be able to deduct them against the dividend income.
The right salary dividend mix can be calculated by an experiences professional. Contact me directly if you are looking for such a calculation.
1) Sale of a personally owned life insurance policy to the corporation. Depending on the individual circumstances, there could be a value paid by the corporation to the shareholder tax-free, in excess of the cash value of the insurance policy. The details are complex and take into account the definition of “value” in subsection 148(9) and the disposition rules in section 148 and subsection 148.
2) IPP – Individual Pension Plans – allows for tax deductible contributions to a defined benefit plan from the corporation. Also can provide lump sum tax deductible contribution room at retirement, and potential top-up deposits depending on plan performance.
3) most life insurance proceeds paid through the Capital Dividend Account on death – tax free to estate.