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Getting Money from your Corporation

Executive Summary

There are numerous ways to take money from corporate earnings while keeping your tax bill to a minimum. Often, business owners opt to receive a portion of corporate earnings through a salary. While others opt to extract profits using a mix between salary and dividends.

Finding the optimal combination to maximize your tax savings depends on many factors including (but not limited to) your cash flow needs, income level, payroll taxes on salary, or the corporation’s income level.

Understanding the tax treatment of payments is important as you want to ensure that the maximum amount of funds is left to be invested back into the corporation.

Earning Options

Paid-Up Capital: If you funded your corporation with a large sum of capital, you may be able to extract funds tax-free by reducing the corporation’s paid-up capital; essentially this is the amount of capital contributed in exchange for shares. Typically, you are allowed to pay shareholders any amount less than the corporation’s paid-up capital without tax consequences.

Repay Shareholder Loans: Another option to receive corporate funds is to repay shareholder loans. If you loaned funds to your own corporation, you are entitled to receive any amount of repayment of the loan tax-free. You may also arrange to have the corporation pay you interest on the loan. Taxation of the interest income is about equivalent to the taxes deducted if the corporation paid you a salary.

Passive income: Investment income earned inside your corporation is classified as ‘passive income’ as it is not generated by direct business operations. The combined tax rates are over 50%, depending on your province of residence, on the taxable portion of earnings. In the case of interest, that is the entire earned amount. For capital gains, half of the gain is subject to the combined tax rate and for dividends the rate is 33.33%. All three of these rates are higher than the highest marginal rate for individuals. Subjecting passive income to higher tax rates within a corporation can lend some benefits like:

  • Building your nest-egg inside the business to fund future expansions
  • Cover short-comings during difficult periods
  • Facilitate borrowing

However, the largest risk with this option lies in losing the capital gains exemption on the sale of shares of a ‘qualified small business corporation.’ As the invested assets build over time, and operating assets decline in value thanks to depreciation, the asset mix could be lopsided. To have the capital gains be exempt, the ‘passive’ invested assets cannot exceed 10% of the fair market value of the corporations’ assets.

Lifetime Capital Gains Exemption (LCGE): For 2021, the LCGE limit per person is $892,218 and is indexed to inflation. This means a married couple who both own shares and can both utilize the exemption could shelter $1.784 million from taxes. Farms and fishing operations that qualify have the individual limit of $1 million per person, allowing a couple to shelter a maximum amount of $2 million. Depending on your goals, a short-term increase in tax and the professional fees associated to establishing the appropriate corporate structure could save you significant amounts of tax in the long run.

Maximizing Capital Dividend Payments: When you have a capital gain, the untaxed portion (one half of the gain) is added to its capital dividend account. The corporation can pay any amount from this account to your client without attracting personal tax. Although this is likely your best option, you must ensure that you make the appropriate tax deductions and remember to file the directors’ resolutions with the CRA.

Bottom Line

Every corporation is going to present varying degrees of needs. When it comes to determining how to pay yourself, be sure to be well informed before making any final decisions. Of course, consulting with a financial expert, like myself, can prove helpful. I encourage you to get in touch with any questions or concerns or to simply learn more.

Book an appointment to discuss how you can get money from your Corporation – Book Here

What Business Owners Need to Know About Health Spending Accounts

Employers are always looking for an edge when it comes to attracting new talent and offering comprehensive employee benefits is one of the best ways to do so. Health Spending Accounts, also referred to as Private Health Services Plans, offer both business owners and their employees a flexible health benefits solution that can work as a replacement or compliment to traditional health plans.

What You Need to Know

  1.  How It Works – A Health Spending Account (HSA) is an account with a predetermined dollar amount that employees can use to cover health expenses that are not covered by their traditional health plan.  The amount in the account is predetermined at the beginning of the year by the plan sponsor (employer).  The employees may apply to be reimbursed for eligible medical expenses for both themselves and their dependents.
  2. What It Covers – Eligible expenses are determined by the CRA. The general rule is you can claim anything that can be claimed as a medical expense by the Income Tax Act. An HSA is available to cover unpaid balances that are not covered by your health plan, governments plans, or your spouse’s plan. For example, the HSA covers services such as vision care, dental care, and drug expenses that are not otherwise covered (such as fertility drugs).
  3. Tax Implications – Businesses may deduct HSA payments made on behalf of employees and their dependents.  Benefits are received tax free by the employees. There are different rules for HSAs for incorporated and unincorporated businesses:

Incorporated

  •  The Income Tax Act does not place a limit on the amount of deductions allowed for HSA premiums in a corporation.
  • Can be set up with only shareholders as employees
  • Payments for medical expenses may only be received by the shareholder as an employee
  • Shareholder must be actively engaged in business activities.
  • Benefits must be reasonable and be consistent with what would be offered to an arm’s length employee.

Self Employed or Partnership

  •  Expenses may be deductible if:
  • Individual is actively engaged in business
  • In current or preceding tax year, more than 50% of income is from the business or individual’s income is less than $10,000 from other sources.
  • Health Spending Account may not be accepted by CRA if the self-employed individual does not have at least one arm’s length employee.

The Bottom Line

Health Spending Accounts are a useful and beneficial tool that can be used by business owners to supplement their employee’s health coverage. Health Spending Accounts can help business owners budget their yearly expense more effectively as the cost of the plan is determined by the business owner, rather than traditional health benefits which have increasing yearly premiums based on claims.  It is important for business owners to pay close attention to the CRA rules surrounding HSAs to ensure that they are eligible for the deductions that are offered to plan sponsors.

Defined Contribution Pension Plans vs Group RRSP: A Guide for Business Owners

Employers have several options available to them when it comes to setting up a retirement savings plan for their employees. Defined Contribution Pension Plans and Group RRSPs are the most accessible plans to most businesses. Here is what you need to know about each plan and how they can work for your employees.

What Is A Defined Contribution Pension Plan?

Defined Contribution Pension Plans are an employer sponsored retirement savings option available to Canadian business owners and their employees. Defined Contribution Pensions Plans are made up of a combination of employee contributions, employers’ contributions, and an optional voluntary contribution component. Defined Contribution Pension Plans are regulated by provincial pension laws, which varies from province to province.

What Is a Group RRSP? 

A Group Registered Retirement Savings Plan (Group RRSP) is an employer sponsored retirement savings plan. Group RRSP’s have many similarities to individual RRSPs with the only difference being that they are administered on a group basis. The plans are made up of employee and employer contributions, but unlike traditional pensions, the employer is not required to contribute any amount to the plan.

Similarities and Difference 

  1. Tax Deferred Savings: Both Defined Contribution Pension Plans and Group RRSPs offer tax deferred savings for employees that contribute to them.  Contributions are taken at the source before tax and contributed to the plans on the employee’s behalf. Both investment options allow employees investments to grow tax free until they retire, at which point the funds with be taxed as they are withdrawn.
  2. Contribution Limits: Both plans are subject to annual contribution limits. This amount is equal to a percentage of each employee’s income from the previous year. Both employee and employer contributions count towards this annual limit.  Both plans will also cause a pension adjustment to employees. This means their individual RRSP will be reduced based on the amount contributed to their employer sponsored plan. This keeps an equal playing field for those who do not have work pensions.
  3. Age Limits: Defined Contribution Pension Plans and Group RRSPs both require that employees stop contributing to the plan and start drawing on the funds at age 71. At this point, employees must convert the plans to an income fund that will pay them out a retirement income.  For Defined Contribution Pension Plans, this fund is called a Life Income Fund (LIF).  LIFs have minimum and maximum withdrawal requirements that plan holders must adhere to.   Group RRSPs holders have two options at age 71. Plan members can a) cash out the plan and pay all tax owing or b) convert the plan to a RRIF and start taking an income.  RRIFs have minimum withdrawal requirements that plan holders must adhere to.

Pros and Cons

Defined Contribution Pension Plans 

Pros

  • Attractive to Employees due to the employer matching component. This can greatly accelerate employee’s retirement savings
  • Funds are locked-in and therefore not accessible until the employee retires. They do not have the option to spend their retirement savings frivolously.
  • Funds grow tax free if they stay in the account
  • Employer Contributions are tax deductible
  • Typically, the investments offered in a pension plan have a much lower fee than traditional investments.
  • Simple, reduced selection of investment options available within the plan.

Cons 

  • Defined Benefit Pension Plans can come with higher administration costs and require continuous maintenance.
  • Due to the fact funds are locked in, employees have little to no flexibility in how they use the money they accumulate.
  • Employer contributions are expected. This can be a significant expense, depending on how many employees a business has.
  • Benefits at plan end are at the mercy of market fluctuations.

Group RRSP 

Pros

  • Employer contributions are not mandatory. This allows for businesses to offer their employees a retirement savings option regardless of the financial abilities of the company, with the flexibility for the company to contribute at any point if it becomes feasible.
  • Funds grow tax free if they stay in the account.
  • Group RRSPS have low start up and maintenance costs.
  • Generally, Group RRSP have a must larger investment shelf than pension plans.
  • No legislative regulation means flexibility for employees to dip into their savings if necessary ie. Home buyers’ program or Lifelong Learners Program.

Cons 

  • Employees have the option to withdraw from the plan at any time, which can severely impact their retirement savings.
  • Larger investment shelves mean more opportunity for employees to take unnecessary or unsuitable risk with their investments.
  • Employer Contributions are a taxable benefit to employees
  • Benefits to employee are not guaranteed and are subject to market fluctuations

Bottom Line

Both plans offer their advantages and disadvantages, with each having something unique to offer. Whichever you choose for your business, you can rest assured you are helping your employees work towards a financially secure retirement!