It’s no secret running a successful business takes time, energy and resources. The problem? It’s easy to get so caught up you lose sight of the big picture when it comes to your personal finances.
Because your business and personal lives cross paths constantly, decisions made for one side often impact the other. Priorities can clash. That’s why taking a well-orchestrated approach to financial planning that balances your business and personal goals is so important.
Build wealth outside your business
When you’re a success, it’s natural to first think of putting capital to work in your enterprise to earn the best investment return. That said, holding too much of your net worth there can be risky. There are always competitive and economic headwinds ready to derail your company’s ability to generate income you rely on or hurt its value.
Plus, when it’s time to finally sell, you can have trouble finding a qualified buyer or walk away with less than you hoped. That’s why it’s smart to build an independent source of capital, say, through tax shelters like a registered retirement savings plan (RRSP) or a tax-free savings account (TFSA).
Look deeper at your income options
Preferential tax treatment is a good reason for an incorporated business to retain its profits. But most business owners also need to pull out at least some of those earnings to fund personal and household expenses. In your situation, is it better to draw income as salary or should you pay yourself a dividend?
Given how our tax system has evolved in recent years, from a tax perspective it often makes little difference which option smaller companies choose. It’s all about the principle of integration; the idea that as cash flows from the corporation into individual hands, the combination of personal and corporate taxes paid should be similar whether income is received as salary or dividends. That turns out to be particularly true when dealing with the first $500,000 of annual business income, which qualifies for the small-business deduction.
But taxes aren’t the only issue. Depending on your objectives, other factors can tip the scales one way or the other.
Building your retirement
If building your RRSP is a priority, wages qualify as earned income for purposes of calculating RRSP contribution room; dividends do not. A salary will also allow you to claim the Canada employment amount.
On the other hand, receiving dividends instead excuses you from the obligation to pay into the Canada Pension Plan (CPP) if you’re OK with forgoing future benefits and would rather put your CPP payments to work elsewhere. What’s more, tax on dividend income doesn’t have to be withheld at source and remitted frequently.
Your advisor can help you weigh the pros and cons to determine if salary or dividends – or a combination of the two – are optimal.
Revisit income splitting
Whether you’re thinking about your business or your household, it’s a good bet your largest annual expense is tax. Fortunately, you have the chance to split income with members of your household, within limits, to minimize your family’s tax bill.
The federal government is proposing to rewrite the rules around income splitting by business owners, so-called “income sprinkling.” The proposals include ensuring salary and dividends paid to family – especially those aged 18 to 24 – are “reasonable” after examining factors like work performed and contribution of capital to the business. The proposed changes amount to an expansion of the “kiddie tax” rules where dividends paid to minor children are generally taxed at the highest marginal rate.
Income splitting isn’t the only area under the microscope. Ottawa is also targeting the conversion of business income to capital gains to reduce tax, as well as passive investments (for example, stocks, bonds or real estate) shielded in a corporation.
The federal proposals are lengthy and detailed, so it’s crucial you’re ready for what might come next. Your tax professional and financial advisor can help you navigate the potential impact on both your personal and business tax situation.
Reach your goals with valuable advice
When you run a business, financial planning can be complicated. Be sure to take a 360-degree view of your financial picture and get financial expertise to create a plan that captures your personal and business goals.
For more articles on business and personal financial planning, visit BlueShore Financial.
