Salary or dividends? Year-end compensation strategy for small business owners
Don't risk paying too much income tax by making the wrong decision about withdrawing funds as salary or dividends.
TORONTO – Small business owners risk paying too much in income tax by making the wrong decision on whether to withdraw funds from their corporations as salary (bonus) or as dividends, says CIBC’s tax and estate planning expert, Jamie Golombek.
In a new report, Golombek offers guidance to small business owners on the most efficient way to pay themselves from their corporations
In light of recent and future changes in tax rates and rules, Golombek outlines the most efficient ways for small business owners to pay themselves from their corporation in a new report, which asseses the impact of the tax rate advantage, the tax deferral advantage and the tax-sheltering benefits of an RRSP.
For small business owners who need to withdraw funds in 2013
“When small business owners need to withdraw funds in 2013 to pay for personal expenses, the 2013 tax rate advantage is an important factor in the compensation decision,” says Golombek. “Paying dividends can generate tax savings when there is a tax rate advantage.”
Paying dividends is generally the best option for SBD Income (income up to the small business deduction limit of $500,000 in most provinces) due to the tax rate advantage in most provinces, which ranges from 0.56% to 4.54% in 2013. For ABI (active business income above the small business deduction limit), paying salary is generally a better option due to the 2013 tax rate disadvantage in most provinces, ranging from 0.47% to 5.88%.
For small business owners who can afford to leave money in the company
“For small business owners who don’t need to withdraw funds in 2013, it can pay to defer dividends to a future year,” says Golombek.
Although there will be a tax cost associated with paying dividends after 2013, there is a significant tax deferral advantage that may help to offset this cost. This year, the tax deferral advantage ranges from 25% to 35.5% across the provinces for SBD Income, and from 13.3% to 23% across the provinces for ABI.
“If investing the deferred amount will generate enough income to offset the tax cost, then paying deferred dividends is the better way to go; otherwise, small business owners should still withdraw funds in 2013,” says Golombek.
Tax-sheltering benefits of an RRSP
While paying dividends may be advantageous in many cases, distributing corporate income as salary rather than dividends creates earned income that allows small business owners to contribute to an RRSP. Small business owners may consider paying sufficient salary to maximize RRSP contributions, particularly if the RRSP invests in higher rate of return, highly-taxed investments over a long time horizon.