You’ve worked so hard to build your business and create a net-positive, profitable company. You’ve got your free cash flow formula locked down (if you don’t, check out part 1 of this series), and you’re ready to start withdrawing some of the profits from your corporation.
Whether you want to treat yourself to that new car you’ve always wanted or need to pull the cash out to maintain your company’s status as a small business for tax purposes, the simple act of withdrawing cash from your business’s bank account will come with a pretty significant tax bill.
So, how do you take money out of your business in the most tax-efficient manner? Well, unfortunately, just like determining your cash flow formula, the answer isn’t as straightforward as you’d like it to be. What works for your business won’t work for the next business—your industry, niche, location, your short and long-term cash flow needs are all unique to your company.
Top 5 Strategies For Taking Money Out Of Your Business
1. Remunerate Your Salary
As a business owner, you typically pay yourself a salary from the business.
If you have family members working for your business, you can pay them a salary as well – provided that it is a reasonable amount or similar to what would be paid to a non-related employee doing the same work.
From a tax perspective, both business owners and family members are taxed on their salaries at regular personal marginal tax rates based on their geographical location. In Ontario, this can be as high as 53.53%. The business can deduct these salaries when the time comes to calculate taxed income, provided the amounts are reasonable.
Generally, any salary or bonuses paid to owner-managers who are active in the business is not questioned by Canada Revenue Agency (CRA), allowing more flexibility in remuneration decisions.
Other benefits of salary include:
- CPP contributions, allowing for greater CPP benefits when you retire
- Creation of RRSP Contribution room – for 2024 this maxes out at $31,560.
- Reduced personal taxes owing in April due to regular payroll remittances to CRA
2. Take Advantage Of Corporate Tax Refunds
You may have been told time and time again that you should leave as much money as possible in your business to allow partially taxed capital to invest and grow, and while this is great advice, there is a caveat. As we’ve mentioned in the previous blog, if you have invested funds earning passive income (which is taxed at a rate of up to 50%), there is an impact on the small business deduction once you’ve earned more than $50,000 of passive income.
Part of that 50% tax rate, though, includes refundable taxes – and if you’ve been earning dividend income, all taxes paid on that income are refundable. This is tracked using a notional account called refundable dividend tax on hand (RDTOH), and is recovered by issuing dividends out to your shareholders. The dividend tax refund is approximately 38 cents for every $1 of dividends issued.
If you plan this out correctly, the additional personal tax you pay may be less than the corporate tax refund that is received from issuing the dividend – a very tax-efficient approach. In Ontario, for this to work, your personal income must be less than $173,000 if issuing regular dividends, or $245,000 if issuing an eligible dividend.
3. Consider Taxable Dividends
Dividends can be used to distribute money from the corporation to you and your family members, provided that you, your spouse, and your children hold shares of the corporation either directly or indirectly (e.g., through a trust).
If you are looking to issue dividends to family members, it’s essential to consider the tax on split income (TOSI) rules and corporate attribution rules before making any distributions, to ensure this method is tax-efficient. It is also strongly recommended to speak with your accountant, or one of our professionals before you go down this route.
TOSI rules dictate that taxable dividends from a private corporation are subject to the highest rate of personal tax, with limited personal tax credits available to offset this tax unless an exclusion from the TOSI rules applies.
Corporate attribution rules state that transfers or loans to a corporation, to shift income to another family member, may result in additional tax for the individual making the transfer or loan unless specific conditions are met. Planning will help to avoid any punitive tax result under the corporate attribution rules.
If you are an active owner-manager in the business – dividends offer an attractive way to take money out of the company, being more flexible than salary and not requiring regular payroll taxes to be paid to CRA.
4. Repay Or Withdraw Shareholder Loans
Just like so many other business owners, you may have loaned funds in the form of a shareholder loan to your company to help finance its start-up or growth in the beginning. Now that you’ve established a good free cash flow, it’s time to consider having your company repay a portion or the entirety of this loan. Any amount that you receive in settlement of your shareholder loan will be a tax-free distribution, similar to a return of capital.
With a little planning and collaboration with your accountant (or outsourced finance department!), you can take a shareholder loan from your company without a formal agreement to temporarily advance funds without it immediately counting as income. To do this, you have to log the loan in your corporate minute book, which will then be reported on the next corporate tax filing. Be careful though, the full remaining balance has to be fully repaid before the end of the next tax year so it isn’t considered personal income.
5. Convert Your Hard ACB
Did you buy your business from someone else? If the answer is yes, it’s entirely possible that the shares you acquired have “hard” adjusted cost base (ACB)—the total amount you paid for the shares. By using a holding company, you can potentially convert this “hard ACB” into cash, allowing you to access your invested capital on a tax-free basis!
You’ve worked hard to earn those profits and deserve to enjoy as much of it as you can! Whether you take advantage of dividends, tax refunds, or shareholder loans, navigating the corporate income tax landscape can feel overwhelming. That’s where our team steps in – CPAs with decades of combined experience are ready to help you and your business make the most of your profits.
Request a consultation, and let’s craft a financial plan that is perfect for your unique business needs.