Have you recently incorporated your business? Wondering about how to pay yourself? Stuck between the options salary or management fees? Then read on to get your answer.
If you own a business through a corporation you can choose to pay yourself a salary or management fee. Let’s discuss the benefits and risks associated with management fees and salary to reach out for a solution that best suits you.
Paying yourself a Salary/ Wage from Corporation
If you opt to have a salary from your business, the payments are the expense of the corporation and employment income for you personally.
How to process your salary payment?
To pay yourself a salary the corporation will need to register a payroll account with Canada Revenue Agency (CRA). Each time a salary is paid, the business is required to withhold source deductions (Canada Pension Plan contribution and Income Tax) from your pay. These source deductions are then remitted to the Receiver’s General (CRA) on a regular basis. Also, each year the corporation must prepare and file T4 slips for any employees that earned wages.
Advantages of Paying Yourself a Salary
Paying yourself a salary can be a way for you to earn a steady and predictable personal income. Some key benefits of using this method include:
- You will be paying into Canada Pension Plan (CPP). This can be a significant retirement consideration as you will ultimately benefit in the future when you will collect CPP retirement benefits, based on how much and for how long you contributed.
- Taxes are automatically withheld from each pay cheque, so when you will file your personal tax return you will have already paid income tax and will avoid a surprise personal tax bill.
- You can take advantage of other investment vehicles for retirement by contributing to a Registered Retirement Pension Plan (RRSP) or a Tax-Free Savings Account (TFSA)
- When you are attempting to qualify for a mortgage or loan, the T4 slip plays an important role. As banks like to witness a stable earning pattern which is endorsed by T4 slip.
- The business salary or bonus paid out will be a tax deduction for the corporation. Salary paid out allows you to build Canada employment credits, reducing the exposure to corporate income tax.
- Paying yourself a straight salary makes it convenient to keep track of your business capital. Salary payment prevents you from withdrawing from your business account every time you need some money.
Disadvantages of Paying Yourself a Salary
- Your personal income is 100% taxable, which might increase your tax load.
- You will be obliged to pay two portions of CPP for both of your roles, being an employee and employer at the same time.
- Increased obligation towards the government. As you have to set up a payroll account with CRA and prepare and file all of the related paperwork.
Paying yourself Management Fees from Corporation
Management Fees are the money paid to managers of an investment company for managing the investment portfolio. A management fee is another way of paying a salary to the owner.
The criteria for the Management Fees to be considered Deductible
Management Fees are often used as a tax planning tool. For management fees to be allowed as a deduction for taxable income, the amount of the fee must satisfy the following conditions:
- The fees must be reasonable in the circumstances.
- The fees must have been incurred for the purpose of earning income and
- There must be a legal obligation to pay the fees.
Advantages of Paying Yourself Management Fees
- Management fees are a legitimate source of revenue that can be used in a variety of tax planning and minimizing techniques. You can claim tax deductions on your personal tax return against the management income received in the year. This will ultimately lower your tax liability. Common tax deductions include home expenses, car expenses, bank charges incurred to operate your business.
- Liberates you from the worries of payroll taxes and the tiresome task of filing monthly payroll forms with the CRA.
Disadvantages of Paying Yourself Management Fees
Management fees have some risk associated with them, as they are often challenged by the CRA where they are not considered reasonable and justified. The CRA is aware that some entities use management fees to eliminate or reduce taxes by shifting income to corporations with losses. In response, the CRA often reviews the deductibility of these fees. In reviewing management fees, the CRA may send questionnaires.
If CRA finds management fee not justifying the above-mentioned criteria it can reclassify the management fees as salary, and then enforce a penalty for failure to withhold payroll taxes.
How to stay in the clear?
Organized and appropriate documentation is critical to substantiate any management fees you have paid (or that are payable) to support a full deduction based on the above requirements. You must maintain the following documents to avoid any CRA suspicions of bona fide management fees:
- A written agreement between you and your corporation
- The agreement must provide the details of the services you will be rendering to your corporation.
- Retain back-copies of time records you served the corporation and detailed description of work performed.
- Receipts mentioning the amount paid and date of payment.
- Ensure that the corporation pays your invoice on time every month.
There are a lot of moving pieces and things to consider when deciding to pay yourself through salary or management fees. If you have any queries to discuss specific to your business situation, then shout out to Filing Taxes – we can help! Feel free to reach out to Filing Taxes at 416-479-8532. Schedule an NTR engagement appointment with us and take the first step towards proper management of your finances.