2021 Year-End Tax Tips for Business Owners
Now that we’re approaching the end of the year, it’s time to review your business finances. We’ve highlighted the most critical tax-planning tips you need to know as a business owner.
Salary and Dividend Mix
As a business owner, one essential part of tax planning is determining the right mix of salary and dividends for both yourself and your family members.
The following are the main options you can consider when determining how to distribute money from your business:
- Pay a salary to family members who work for your business and are in a lower tax bracket – This enables them to declare an income so that they can contribute to the Canada Pension Plan (CPP) and a Registered Retirement Savings Plan (RRSP). You must be able to prove the family members have provided services in line with the amount of compensation provided.
- Pay dividends to family members who are shareholders in your company – The amount of dividends someone can receive without paying income tax on them will vary depending on the province or territory they live in.
- Distribute money from your business via income sprinkling – This is shifting income from a high-tax rate individual to a low-rate tax individual. However, this strategy can cause issues due to Tax On Split Income (TOSI) rules. A tax professional can help you determine the best way to “income sprinkle” so none of your family members are subject to TOSI.
- Keep money in the corporation if neither you nor your family members need cash – Taxes can be deferred if your corporation retains income and the corporation’s tax rate is lower than your personal tax rate.
No matter what strategy you take to distribute money from your business, keep in mind the following:
- Your marginal tax rate as the owner-manager.
- The corporation’s tax rate.
- Health and payroll taxes.
- How much RRSP contribution room do you have.
- What you’ll have to pay in CPP contributions.
- Other deductions and credits you’ll be eligible for (e.g., charitable donations or childcare or medical expenses).
An important part of year-end tax planning is determining appropriate ways to handle compensation. The following are the main things to consider:
- Can you benefit from a shareholder loan? A shareholder loan is an agreement to borrow funds from your corporation for a specific purpose. The interest from the loan may be deductible if the proceeds of the shareholder loan were used to produce income from business or property.
- Do you need to repay a shareholder loan to avoid paying personal income tax on the amount you borrowed?
- Is setting up an employee profit-sharing plan a better way to disburse business profits than simply paying out a bonus?
- Keep in mind that when an employee cashes out a stock option, only one party (the employee OR the employer) can claim a tax deduction on the cashed-out stock option.
- Think about setting up a Retirement Compensation Arrangement (RCA) to help fund you or your employee’s retirement.
One of the most common tax advantages available to Canadian-Controlled Private Corporations (CCPC) is the Small Business Deduction (SBD).
For qualifying businesses, the SBD reduces your corporate tax rate. Keep in mind that the SBD will be reduced by five dollars for every dollar of passive investment income over $50,000 your CCPC earned the previous year.
The best way to avoid losing any of the SBD is to make sure that the passive investment income within your associated corporation group does not exceed $50,000.
These are some of the ways you can make sure you preserve your access to the SBD:
- Defer the sale of portfolio investments as necessary.
- Adjust your investment mix to be more tax efficient. For example, you could choose to hold more equity investments than fixed-income investments. Only 50% of the gains realized on shares sold is taxable, but investment income earned on bonds is fully taxable.
- Invest excess funds in an exempt life insurance policy. Any investment income earned on an exempt life insurance policy is not included in your passive investment income total.
- Set up an individual pension plan (IPP). An IPP is like a defined benefit pension plan and is not subject to the passive investment income rules.