July A Good Time To Review Owner-Manager Compensation

It's half time, and that's a good time to review the income requirements of the owner-manager you may be working for. How should you begin this process? Here are some tips to consider:

First, in determining the optimum income plan, each individual family member's total income and type will be important. It is important to ensure that the family member has enough total income to utilize fully his or her personal credits, excluding those that can be transferred to other family members. These are discussed below. So, the total amount of income is important.

The type of income is equally important.

The payment of a reasonable salary, for example, will increase both net and taxable income. It will also normally attract CPP and (often) EI contributions, both of which give rise to additional personal credits and may increase the family member's Canada Employment Credit. A decision to pay additional salary must take these into account.

Another key issue is the fact that a salary is earned income for purposes of creating RRSP contribution room. If it is desirable to allow family members to accumulate retirement income there may be a preference for paying a salary.

Dividend income, on the other hand increases both net income and taxable income as well, but also provides the dividend tax credit. Issues that need to be taken into account in evaluating the payment of a dividend as compensation include:

  • the taxable amount of the dividend is greater than the cash amount, so dividends have a greater effect on clawbacks than do salary, dollar for dollar;
  • dividend income is not earned income and does not create RRSP contribution room;
  • dividend income is investment income for purposes of computing the Cumulative Net Investment Loss account, and the receipt of a dividend may increase access to the capital gains deduction;
  • dividends paid from a private corporation to a minor will normally attract the kiddie tax, meaning that they are taxed at the highest possible rate;
  • because of the dividend tax credit, the tax treatment of the dividend must be modeled closely where the taxpayer has relatively low income and may be in danger of not utilizing all of his or her personal credits.

For more information on owner-manager tax planning, take The Knowledge Bureau's certificate course entitled Tax Planning for Corporate Owner-Managers.

Next Time: Pitfalls with Surplus Investments Held in Corporate Accounts