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The Canada Revenue Agency issued a reminder to businesses about some of its services and calculators that are available to help entrepreneurs to mark Small Business Week, which runs from Oct. 15 to 21.
For starters, the CRA offers a free Liaison Officer service to owners of small businesses and self-employed individuals to help them understand their income tax, GST/HST and payroll obligations. A virtual visit or webinar with a liaison officer is free and 100 per cent confidential. The information you choose to discuss with the liaison officer won’t be shared with other areas of the CRA (or anyone else). These personalized sessions provide support and guidance, and help ease the stress of tax filings.
The CRA also offers a couple of online calculators that may be of interest. The Payroll Deductions Online Calculator can help business owners simplify the process of calculating federal and provincial tax remittances, Canada Pension Plan (CPP) contributions and Employment Insurance (EI) premiums to be deducted from employee wages. There’s also a GST/HST calculator, which helps determine the correct amount to be charged or claimed on sales and purchases, allowing business owners to collect and remit the appropriate amount of GST/HST.
Finally, the CRA reminded business owners that they can post a question to Charlie the chatbot about their business and other tax-related matters. Charlie was asked more than 854,000 questions in English and just over 156,000 questions in French from April to July 2023.
A common question I get asked by incorporated business owners towards year-end, and one which was a bit too complex for Charlie to answer (I did give it the chance), is how to pay yourself for 2023.
The issue arises because there is flexibility in how owners can be remunerated as an incorporated business. The same holds true if you are a professional, such as a doctor, lawyer or accountant, who has incorporated a practice using a professional corporation. This flexibility stems from how a corporation distributes its income to a shareholder who is also an employee: either as salary or dividends.
If corporate business income is paid to you as salary (or a bonus), your corporation (which is also your employer) can claim an income tax deduction for the salary (and applicable payroll taxes such as CPP and EI), which reduces its taxable income. You then include the salary in your taxable income and pay tax on that income at personal graduated tax rates.
As an alternative, your corporation can pay tax on its corporate income in the year the income is earned. In that year, or a future year, the corporation can distribute its after-tax corporate income to you as dividends. You will pay a lower tax rate (as compared to salary) on eligible and non-eligible dividends due to the dividend tax credit, which is meant to compensate for taxes paid by your corporation.
Let’s take Fred, an incorporated physician, whose professional corporation is expected to earn $100,000 of taxable income in 2023, after all expenses and overhead. If Fred is a resident of Ontario, and assuming the corporation qualifies for the small business rate of 12.2 per cent on active business income, the corporation would pay $12,200 in corporate income tax for 2023. The net amount, $87,800, would be left in his corporation and invested, or be paid out currently or in a future year.
If the $87,800 is paid out, it will be taxed as a non-eligible dividend, and if Fred is in the top Ontario marginal tax bracket in 2023 (due to other income), he would pay approximately $41,920 on this dividend, netting him $45,880 after tax. The net result is that on $100,000 of net income, Fred will have paid total tax of $54,120 for an effective integrated combined tax rate of 54.12 per cent.
This rate is only slightly higher (0.59 percentage points) than the top Ontario personal tax rate of 53.53 per cent on salary income. This means that if Fred had decided to pay himself a salary of $100,000, his professional corporation would claim a tax deduction for the salary expenses, have no net income and pay no corporate income tax.
Fred would pay personal tax on that $100,000 salary at his marginal rate, which if he had significant other income, could be as high as $53,530. Contrast that with the $54,120 total tax paid on the dividend compensation method above, and the difference in total tax payable is a mere $600.
Of course, what the rate comparison fails to acknowledge is the tax-deferral advantage of leaving funds in your corporation. Suppose Fred didn’t need any corporate income to live on, because he has other sources of income, so he can afford to leave it all in his corporation. The corporation would pay a bit of income tax currently ($12,200), leaving $87,800 in the corporation where it can be invested for years, if not decades. The deferral advantage, 41.33 percentage points, is simply the difference between the top rate (53.53 per cent) and the small business rate (12.2 per cent).
This deferral advantage is significant, and ranges across the provinces and territories from a 2023 low of 32.5 percentage points in Nunavut to a high of 42.8 percentage points in Newfoundland and Labrador. Business owners who do not currently need all their corporate income for personal use may benefit by leaving those excess funds (deferred tax) in their corporation.
There are, however, a few other things to keep in mind. Paying a salary or bonus allows you to make a registered retirement savings plan (RRSP) contribution. Receiving a salary of at least $175,333 by Dec. 31, 2023, could allow for the maximum RRSP contribution of $31,560 in 2024 as it’s based on 18 per cent of the prior year’s income. An RRSP can effectively provide a tax-free rate of return on investments.
If, on the other hand, you don’t need funds from your corporation, you may still wish to pay yourself enough cash, via salary or dividends, to maximize your annual tax-free savings account (TFSA) contribution, with the TFSA dollar limit expected to increase to $7,000 for 2024. The TFSA can provide tax-free returns, which is better than having the corporation invest the funds when it pays tax at relatively high rates on investment income.
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With Dec. 31 fast approaching, now is the time to review your year-end compensation plan with your tax and legal advisers.
Jamie Golombek, CPA, CA, CFP, CLU, TEP, is the managing director, Tax & Estate Planning with CIBC Private Wealth in Toronto. [email protected].
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