When family members work for the company
A company can employ a family member and pay a salary. This includes a spouse or child, including a minor child. However, the salary paid must be commensurate with the work performed and what might otherwise be paid to an independent third party. If an unreasonable salary is paid, there is a risk that the Canada Revenue Agency (CRA) will withhold income from the company and the income will continue to be taxed by the recipient.
A family member can also be a shareholder and receive dividends (even if they also receive a salary). Tax on Split Income (TOSI) rules can result in dividends paid to family members being taxed at the highest rate unless certain criteria are met. The most common exceptions include a family member who is actively involved in the business (working an average of 20 hours or more per week) or the dividend recipient’s spouse is 65 or older. The TOSI rules are complex and should be discussed with an accountant.
A common mistake for retired entrepreneurs is to keep paying a salary. It can be difficult for a company to justify a salary deduction for an investment holding company that is no longer active. The wage tax withholding can be wasted due to low corporate income or lack of deductibility, and the salary could be personally taxed more heavily than dividends. Retired entrepreneurs should generally pay dividends rather than salaries.
Some business owners, especially those over 60, should consider paying out salaries or dividends from their business at all. If a business owner has a large RRSP balance, especially if their expenses are relatively modest relative to their assets, they may want to consider starting RRSP withdrawals. They may be able to keep their corporate earnings in their company, pay a relatively low corporate tax rate, invest their corporate savings, and start drawing RRSPs instead.
Having high RRSP is a good problem, but it can be very stressful in retirement or after death. Some retirees can pay up to 62% tax on RRSP withdrawals after age 65 if they are subject to Old Age Insurance Reclaim (OAS). If the second spouse dies, any remaining RRSP credit can be taxed at up to 54%.
RRSP withdrawals can be deferred until the age of 72, but it is often beneficial to start withdrawing earlier. Corporations, on the other hand, do not have mandatory withdrawals. Unlike RRSPs, there can be tax efficient ways to leave business assets to children or grandchildren using trusts, life insurance, or other strategies to lower the taxes payable on withdrawals from a company after death.
When an entrepreneur has a stake in their business, it sometimes makes sense to pay dividends to yourself and other shareholders even when they don’t need the money. Certain dividends result in tax refunds to a corporation, and the tax savings for the corporation may be greater than the tax payable by the individual. Certain dividends can also be tax-free for the recipient. In other cases, the investment income later earned by the individual may be taxed at a lower tax rate than would otherwise be paid by the corporation (which pays a high tax rate on investment income).
Entrepreneurs must take into account many largely tax-driven financial planning considerations. It is a mistake to simply have an accountant prepare your tax return without proactively discussing tax considerations such as compensation planning, which take into account the income and assets of businesses and individuals.