Blog: Dividends, Wages and Payroll for Family BusinessesOctober 1st, 2014
Working with a large number of small and medium sized family businesses we notice trends in the type of questions that are most frequently asked. One such type of question relates to remuneration of shareholders and employees.
Generally speaking, there are two ways of getting money out of a corporation and into an individual’s pocket: wages and dividends. While it is impossible to provide a one-size-fits-all answer to the question of which is better, we can look at some of the implications of wages vs dividends to better inform our decision-making and therefore determine what’s right for each unique circumstance.
The good news for the employee with respect to wages (other than getting a paycheque) is that wages are considered ‘earned income’. As a result wages provide the employee with RRSP contribution room as well as allow the employee to receive Canada Pension Plan (CPP) and Employment Insurance (EI) benefits (provided the employee isn’t exempt from EI).
The bad news for the employee is that there would be no preferential tax credits, like the dividend tax credit, on the wage payment. This means that the wages are simply taxed at the employee’s marginal tax rate.
The good news for the employer is that it receives a full deduction for the amount of wages paid. This is because the wages are a cost to the employer to earn income and also because the amount would be taxed in the hands of the individual at the time the wages are paid.
The bad news for the employer is that there would be a requirement to remit EI, CPP and personal income taxes on behalf of the employee(s) which could significantly increase the amount of red tape and therefore costs to the corporation.
Employment Insurance is a payroll tax that is a cost of paying and earning wages.
The employee is required to pay EI of 1.88% of the employee’s wages up to $48,600 (for 2014). That means that the maximum employee portion of EI in 2014 is $913.68.
In addition to the above, the employer is required to remit 1.4 times the amount of the employee’s portion on behalf of the employee. As a result the maximum amount of the employer’s portion (for 2014) would be $1,279.15.
When the employee and employer portions are combined, the employer is potentially required to remit a total of $2,192.83 on behalf of each employee, assuming the employees earn more than $48,600.
The above represents a significant cost to employ staff. Fortunately, CRA allows for certain employees to be exempt from EI. Some of the more common situations include the following:
Casual employment if it is for a purpose other than your usual trade or business Employment when you and your employee do not deal at arm’s length (i.e. individuals connected via blood relationship, marriage, common-law relationship etc.)
When a corporation employs a person who controls more than 40% of the corporation’s voting shares
NEWS: The Department of Finance recently announced employers that pay employer EI premiums of less than $15,000 in 2015 and/or 2016 will be eligible for a credit reducing the employer EI premiums by 39 cents per $100 of insurable earnings (this represents a reduction of about 15%).
TIP: Advice from your Crowe MacKay professional should be received before utilizing an EI exemption as CRA may take exception and reassess for EI amounts owing if they disagree with the use of the exemption.
CANADA PENSION PLAN
Canada Pension Plan is a payroll tax similar to EI but has a few notable differences.
The first $3,500 of wages earned are exempt from any CPP withholdings. This means that the employer can pay wages up to $3,500 per year and not have to worry about calculating CPP. After the first $3,500 the employee is required to pay 4.95% of their wage as a CPP withholding up to a wage level of $52,500. Therefore the maximum amount of the employee portion of CPP (for 2014) is $2,425.50.
The employer is required to match the employee’s contribution. As a result the total amount that the employer would be required to remit on behalf of the employee, assuming the employee earned at least $52,500 during the year, is $4,851.
CPP is required to be withheld and remitted for all employees between the ages of 18 and 65 on their pensionable earnings (i.e. wages and salary). At 65 the employee can elect to stop paying CPP if he/she is continuing to work and already collecting CPP. At age 70 the employee will stop making CPP contributions.
TIP: If you are between the ages of 65 and 70 your Crowe MacKay professional may be able to assist you to opt out of the Canada Pension Plan if you no longer wish to contribute.
The main benefit of dividends to the individual is that they are paid from after-tax corporate earnings. As a result the individual recipient is entitled to a dividend tax credit to offset the corporate tax previously paid. Due to the dividend tax credit the individual could receive upwards of $35,500 of regular dividends or $50,000 of eligible dividends (in 2014) with little to no federal personal income taxes owing, assuming no other income is earned by the individual.
Another benefit of dividends is that they are not subject to payroll remittances as they are not salary. Therefore the red-tape burden of paying dividends is reduced.
Despite the benefits above there are some trade-offs to dividends. In particular dividends do not represent ‘earned income’ and therefore they do not entitle the individual to CPP, EI or RRSP contribution room. As a result, if an individual were to only earn dividends they would never be eligible for CPP, EI or RRSPs. Dividends could also result in the individual being required to remit quarterly personal tax installments if the year-end tax payment in the current year and either of the preceding 2 years is greater than $3,000.
PAYMENTS TO FAMILY MEMBERS
– A Few Words Of Warning
Reasonability of wages
The general rule with respect to payments to family members is that they need to be reasonable. Reasonable to CRA is paying a family member the employment income that would have been paid if the work was performed by a 3rd party and not by the family member.
The risk with respect to payments to family members is if CRA determines that the amounts paid are unreasonable they will deny the deduction in the corporation but the individual could continue to be taxed for the amount received. The end result being double taxation.
Another issue to consider with respect to payments to family members is kiddie tax. The rules can get complex but generally if dividends from a private corporation are paid to minor children who have not attained the age of 17 before the year then those payments will be taxed at the highest marginal rate. The result being that there will be no income splitting potential with respect to these payments.
A NOTE ON TAX INTEGRATION
It should be noted that the Canadian tax system is designed so that a corporation can’t be used to reduce income taxes but under the right circumstances it can be used to defer income taxes to a later date. As a result the combined net corporate and personal tax bill will be roughly the same regardless of whether wages or dividends are paid to shareholders but the timing of the tax payment will vary.
For example, the individual is taxed on the wages earned at the time they are paid. The corporation receives a full deduction of the amount of wages paid. Dividends on the other hand provide the individual recipient with a dividend tax credit because the corporation doesn’t receive a deduction on the payment of the dividend. The dividend tax credit therefore offsets the corporate income taxes previously paid to ensure the dividend payment doesn’t result in double taxation.
The decision between remuneration via wages or dividends can get complex and unfortunately there is no one-size-fits-all answer. Please consult your Crowe MacKay professional to determine a remuneration plan that is right for you, your employees, your family and your business.
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