How to Pay Your Shareholders
How to Pay Your Shareholders
If you are an owner/shareholder, you may be wondering how to take out money from your company. Perhaps the company has excess cash on hand or you are in need of funds for living expenses. How you are compensated as a shareholder will impact what expenses the company can deduct, as well as the taxability of the payment to the shareholder. With this in mind, it is important to consider the intent of the payment, as well as its taxable impact on both the company and its shareholders.
Shareholders can receive payments from a company through salary, dividends, or in the form of a loan. A brief discussion of each method follows:
Payments to a Shareholder as Salary
In many cases, a shareholder may play an active role in a company. As such, they may be paid a salary for their services. Salary payments are taxable as income to the shareholder and are tax deductible for the company. The appropriate taxes are withheld from a shareholder’s paycheck and remitted to the Canadian Revenue Agency(CRA) as required. At the end of the year, the shareholder will receive a T4 slip, which will document the amounts paid and taxes or other items withheld from their salary.
Family members of shareholders may also be paid a salary. Amounts paid as salaries to shareholders and their family members should be reasonable based on the services being provided, as well as the amount paid. The salary expense for shareholders or their family members that are considered excessive by the CRA may not be fully deductible by the company.
Many companies opt to pay a salary to a shareholder as a means to keep their overall tax rate in a lower bracket. If you are an owner/shareholder and actively participate in the operations of a company, this may help to keep the company’s taxable income under the small business threshold rate of $500,000.
If you choose to pay a shareholder a salary, however, there are other expenses that should be evaluated.
Expense Payments– If you pay personal expenses on behalf of a shareholder, this is considered taxable income to them. The company would determine the value of the benefit received by the shareholder and include this as taxable income.
In some cases, these expenses can represent a combination of business expense and personal benefit. A company should evaluate the amount for both personal and business expenses and keep proper documentation to support this calculation. Documentation can include receipts, invoices, or other supporting materials.
The CRA can challenge this allocation, which may mean that the shareholder would need to pay more tax on any additional amounts that are considered to be personal expenses paid on their behalf. Therefore, keeping receipts, invoices, as well as any other written documentation is necessary.
Canadian Pension Plan– A company is required to match the contribution made by the employee into the Canadian Pension Plan, or CPP. If a shareholder is paid a salary, the company would be required to match any contribution made. CPP contributions are limited based on the earned income of a shareholder.
Employment Insurance– If the shareholder owns at least 40% of the stock of the company, no contribution is required to be made by the company. However, if the ownership is less than 40%, payment into the Employment Insurance (EI) fund will be necessary.
Family members of a shareholder who owns at least 40% of the company may also fall under this exemption if their position is not considered arm’s length and the job would not have been held by a person that is not related to the company.
Even if the ownership percentage is 40% or more, the company can choose to pay into the EI fund on behalf of shareholders.
Employer Health Tax– Effective January 1, 2019, British Columbia implemented the Employer Health Tax(EHT) provision whereby a company pays in a percentage of its total salaries and benefits into a fund. This tax is required if the total salaries and benefits exceed the threshold of $500,000. The amount that is greater than $500,000 is taxed at a rate of 2.925%. This rate applies up to $1,500,000 in total remuneration. Benefits paid in excess of $1,500,000 are taxed at a rate of 1.95%. All salaries paid by the company are included in this determination, even those paid to shareholders.
In addition to salaries, other payments such as contributions to an individual’s registered retirement savings plan are included in the determination of total salaries and benefits paid by the Company.
Payments to Shareholders as Dividends
A dividend is a payment made to shareholders out of a company’s accumulated earnings. They are paid out according to the percentage ownership that each shareholder has.
The benefit of paying dividends to a shareholder is that they are subject to a lower tax rate at the personal level when compared with the tax rates for earned income. While the company won’t receive a deduction for dividend payments as they are paid out from earnings that have already been taxed, they can receive a credit for the taxes that they did pay on these distributions.
As a shareholder, if you intend to make payments toward the CPP, any dividend income will not count when an individual determines how much they would like to pay in. Keep in mind that dividends are paid out to all shareholders of a company based on their ownership percentage. If your intent is to pay just one shareholder, but the company has multiple shareholders, paying out dividends may not be the best option.
Shareholder Loans
Shareholders may take a loan from the company. There is no taxable impact of taking out a loan, with the exception of any interest charged or if the loan is not repaid. Any interest that is paid by the shareholder to the company on the loan is considered income to the company.
In some cases, shareholders may have loaned money or paid company expenses on its behalf. Repayments received by the shareholder are not taxable income, nor are they allowed as an expense deduction.
Valley Business Centre
If you are an owner/shareholder of a company and are looking to be paid, there are many options available to you. Careful consideration of each option is necessary to determine the tax impact on both the shareholder and the company.
To ensure that your books and records are up-to-date, contact the bookkeeping professionals at the Valley Business Centre. Offering reliable and timely service, Valley Business Centre has served small-to-medium sized companies with their bookkeeping and payroll needs since 1990. We work with clients that are located in the BC area and throughout the region. For more information, contact the bookkeeping specialists at Valley Business Centre today.
What Your Books and Records Reveal About Your Company
Your books are great story-tellers. While your financial reports may seem like nothing more than a bunch of numbers on a page, they can reveal volumes about the health and direction of your company. Your books and records can tell the story of success, growth, or challenge.
What are some of the stories that your books can tell?
Your business makes money – “How much money did I make” is usually the first thing on everyone’s mind. Profitability is often seen as an indication of a successful business. If you’re bringing in more money than what you are spending, that’s a good start.
You can’t stop there. Be sure to take a closer look at your revenue and expenses.
Is there room for more profitability? – One approach to improving profitability is to sell more of your products or services. Consider a few things;
- Are add-on services or products an option? If your company performs IT services, are ongoing maintenance contracts an option? Should you expand your product offerings to include hardware?
- How do your prices compare with your competitors? Are they higher, lower, or about the same? If you are finding that your prices are lower than your competitors, you may not be charging enough to cover your costs. If your offerings are similar to your competitors, you may be pricing yourself out of the market if you are charging more.
- If you sell multiple products or services, which ones stand out? Which ones are you spending the most money and time selling? If you find that you are spending more effort selling a product that generates a low amount of profit, you might consider focusing your efforts on products or services that have a higher return.
While the common approach to improving profitability is simply to increase your sales, it’s not the only plan. Take an overall look at what you are spending for the month and for the year.
Determine if these payments are:
- Absolutely necessary – Expenses such as rent, utilities, and insurance are typical expenses that you would expect to pay every month. You may have some leeway to reduce these amounts when you renew your lease or insurance policy. If you choose to install LED lights or updated thermostats, you may save on utility bills.
- Important, but may be improved – Some of the expenses we pay each month are necessary, but amounts may be further reduced. Phone bills and internet service are great examples where you may be able to negotiate a lower amount if they have a better service plan available. If you have a seasonal business, some utility and credit card companies may allow you to put a “hold” on your account, which allows you to pay a smaller fee to keep the account open, but not the full fee until it’s in use.
- Nice to have, but not necessary – These are the expenses that can be reduced or eliminated. Meals and entertainment expenses often fall under this category. Perhaps choosing less expensive restaurants or limiting the dollar amounts spent will keep this under control.
Small changes that you make to recurring expenses can have a significant impact over time. Even saving $100 per month will add up $1,200 for the year. Money that is spent on non-essential items should be re-evaluated. Companies that pay monthly bank service fees may be able to reduce these expenses, even eliminate them, if they switch to a different bank.
If you sell a product or service that has a direct cost, analyze how profitable it is. Are you making enough of a margin to cover your indirect costs, such as rent, utilities, and administrative payroll? If not, you may be paying too much for their direct cost or you aren’t charging your customers enough.
Can you pay the bills? – While a statement of income can show that you are making a sizable profit, that’s only part of the picture. A company’s liquidity, or how much money they have to pay bills, tells a story as well. Comparing your current assets against your current liabilities can give you a quick snapshot of your liquidity.
For example, if your current assets are $100,000 and your current liabilities are $50,000, you have two times the amount needed to pay your bills. That’s a good position to be in. If the amounts were reversed, a company could run into a cash flow issue if they need to pay $100,000, but only have $50,000 available.
What does the company value? – Many companies have mission and vision statements on their websites. A business of any size can adopt a corporate social responsibility program. But is what they are paying for consistent with their plans?
You can tell quite a bit about a business by the way in which they choose to spend their money. Companies that are employee-focused typically spend more money on training, recruiting, and benefits. For those who are looking to grow or innovate, disbursements for technology, new staff, or equipment would be expected. Those that offer programs with a charitable intent should have donations being made. How a company spends its money can reflect what they value.
Is your story current? – The story your books tell is only as good as the record-keeping that goes into preparing them. If your books are behind, what does this mean? If you are a sole business owner and are struggling to stay on top of things, a set of books that is months behind can be a signal that you have too much on your plate. You may want to consider outsourcing this task. Not only does come off of your plate, but it will also actually give you more control over your company’s finances as your time will be spent reviewing financial reports, not preparing them.
When your books are behind, it can also tell a story that management doesn’t place much emphasis on keeping current records. If you are looking to obtain a loan from a bank or purchase equipment on credit, this is not a story that you want to tell.
Books and records can reveal many things about a business – where it is successful and where it can improve. The most accurate story can be told when your accounting records are current. Since 1990, Valley Business Centre has helped small and medium-sized businesses stay current with their bookkeeping and payroll functions. We serve clients through the BC region and beyond. If you are struggling to keep your bookkeeping and payroll up-to-date, we can help. Contact the bookkeeping specialists at Valley Business Centre today.