Given that many business owners would want to be aware of missing pocket change, I asked him about it:
“Oh the 50,000?” he replied. “Glad that you asked! You see, it’s my business right? Of course, when we get a lot of cash sales, I go to deposit the money in the bank. On the way to the bank, my friend asked me for some money. What, I'm not going to give a friend money? It’s my business – so I gave him the cash! ”
Now you’re probably not giving away wads of cash to your friends in your business, and if you are, I wouldn't mind having you over for dinner.
Each pay period you’ll receive a payment issued from your company, less payroll deductions just like you did if you were employed for someone else. The difference here is that you’ll likely not be paying employment insurance (EI) deductions as the owner of the business – not to mention the fact that you get to set your salary.
When you receive a salary, the company will deduct the amount from corporate income, and the amount your receive will be added to your employment income when you file your personal tax return.
At some point in the year, your company can “declare” dividends. You can then take out the full amount of the dividend, without any deductions. Tax wise, rather than deducting the amount from the corporation’s income, the company actually pays tax on the gross amount. So for example, if your corporate profit is $50,000 but you declare a dividend of $10,000, you’ll still need to pay corporate income taxes on the original $50,000. The good news is that tax rates are much lower when it comes to dividends so while you’ll pay some corporate tax, you’ll pay a lower rate on your dividend income when you file your personal tax return.
For many small businesses in the beginning stages, setting a consistent salary may not be optimal. As you’re in the growth stage of your business, you may not know how much money you’re going to make to be able to take out a set amount each week. That’s where the “shareholder's loan” account comes in.
With the “shareholder's loan” account, each time you take out money, think of yourself as “borrowing” from the company. Throughout the year, you can take out money on a per-need basis and record all your withdrawals in the “shareholder’s loan” account. At the end of the year, this account will reflect all the funds that you either put in or took out from the company.
Keep in mind that while you may have taken money out of the company, you haven’t really “taken it out” for tax purposes – you've really just borrowed it at this point. The actual “taking it out” from the CRA’s point of view occurs when you set a salary/bonus or declare dividends. That’s how you tell the CRA that you've actually taken out the money and not just gave it away to a friend (see note on dinner invite above).
You may then suggest leaving the shareholder’s loan account the way it is for the life of the company. After all, if you declare dividends or take out a salary, there may be tax to pay. If you continue to simply borrow from the company, all withdrawals are tax-free.
Why tell the CRA that you’re taking out money anyway?
Unfortunately, the CRA has put strict rules on the shareholder's loan account. If you “borrow” from the company for too long, the CRA will simply declare it as income and you’ll have to include it in your personal return.
Since each business is different and each person’s personal tax situation is unique, the mixture of salary/bonus and dividends will vary across the board – there is no “right” combination.
However, using the shareholder’s loan account, you can then sit down with your accountant at the end of the year and decide whether to set a portion of the loan you took out as a bonus (like salary) or as dividends to ensure you are optimizing your tax situation. So, if you’re thinking about giving away a wad of company bills to the next person that pokes you on Facebook, make sure you’re aware of the tax consequences.