Salary or dividends? CIBC Expert Gives the Inside Scoop for Startup Owners and Their Year-End Compensation Strategies

Its the end of the year, and for startups that means office Christmas parties and for some, year-end bonuses or dividends.

Small business and startup owners could end up paying too much in income tax by making the wrong decision on whether to withdraw funds from their corporations as salary (bonus) or as dividends. That’s according to a new report by CIBC.

In light of recent and future changes in tax rates and rules, small business owners need to know the most efficient way to pay themselves from their corporations. The report, written by CIBC’s tax and estate planning expert, Jamie Golombek, assesses the impact of the tax rate advantage, the tax deferral advantage and the tax-sheltering benefits of an RRSP as factors that can affect the compensation decision for small business owners.

“Each year, small business owners who run their businesses through corporations can choose to receive compensation from their corporations as either salary or dividends,” said Golombek. “This year, changes such as increases in the highest personal marginal tax rates in several provinces and modifications to taxation of dividends will significantly impact the compensation decision.”

Small business owners who need to withdraw funds in 2013

“When small business owners need to withdraw funds in 2013 to pay for personal expenses, the 2013 tax rate advantage is an important factor in the compensation decision,” said Golombek. “Paying dividends can generate tax savings when there is a tax rate advantage.”

Paying dividends is generally the best option for SBD Income (which is income up to the small business deduction limit of $500,000 in most provinces) due to the tax rate advantage in most provinces, which ranges from 0.56 percent to 4.54 percent in 2013. For ABI (which is active business income above the small business deduction limit), paying salary is generally a better option due to the 2013 tax rate disadvantage in most provinces, ranging from 0.47 percent to 5.88 percent.

Small business owners who can afford to leave money in the company

“For small business owners who don’t need to withdraw funds in 2013, it can pay to defer dividends to a future year,” said Golombek.

Although there will be a tax cost associated with paying dividends after 2013, there is a significant tax deferral advantage that may help to offset this cost. This year, the tax deferral advantage ranges from 25.00 per cent to 35.50 per cent across the provinces for SBD Income, and from 13.30 per cent to 23.07 per cent across the provinces for ABI. Mr. Golombek added, “If investing the deferred amount will generate enough income to offset the tax cost, then paying deferred dividends is the better way to go; otherwise, small business owners should still withdraw funds in 2013.”

officeAlso, we hope your Christmas party isn’t like this one:

On that note as well, we’re sponsoring Montreal’s TechNoel, happening tomorrow night. For tickets click here.

Toronto is also hosting its annual HoHoTo holiday startup bash on December 19.

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