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.
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.