Home » How To Pay Yourself as a Canadian Business Owner
You should give serious consideration to how you withdraw funds from your business enterprise. Usually, there are two options for doing that: a salary or an owner’s draw.
Let’s examine the differences between a salary and a draw to help you decide which is best for you and your company.
Some business owners receive a salary from their companies, while others receive an owner’s draw. But how can you tell which (or both) are the most viable options for your company? And best for you on a personal level? Here are some tip to help you figure it out.
Understanding the Difference Between Draw and Salary
Understanding the fundamentals is necessary before you can choose the approach that works best for you. An overview of the differences between a wage and an owner’s draw (or, simply, a draw) is provided below:
Owner’s Draw: When a business owner withdraws money for personal purposes. Draws can take place on a schedule or as needed.
Salary: Each standard pay period, the business owner cuts themselves a paycheque based on the fixed wage or sum of money they have determined for themselves.
Your business classification is the main aspect that will determine whether you choose a salary, draw, or another form of payment (such dividends). The primary kinds of business entities are:
Why does this matter so much? Because the regulations governing the compensation of business owners vary depending on the type of business structure. For instance, if your company is a partnership, you are not permitted to be both a partner and an employee, according to Revenue Canada, therefore cannot pay yourself a salary.
You’ll hear the phrase “owner’s equity” a lot when deciding whether to take a salary or a draw from your business. Equity is described by accountants as the amount still invested in a business after all obligations have been subtracted.
You gain equity—another term for ownership—in your business entity when you invest money, tools, and other assets in it. This means you can withdraw money from the company on an annual basis.
It’s important to understand your equity because, should you decide to take a draw, the total of your withdrawals cannot exceed your overall owner equity.
There are several tax ramifications to take into account, in addition to the various regulations governing how different business structures permit business owners to pay themselves.
Canada recognizes five major corporate categories. None is ideal for everyone, but each has benefits for particular business models and tax rates. Before choosing one of these forms for your company, be sure to seek guidance from a professional (preferably accountants like us.)
How Much Should You Earn?
There’s a lot that goes into figuring out how to pay yourself. But here’s your next question: How much should you pay yourself?
There’s not one answer or formula that applies across the board. You’ll need to take the following factors into account:
Again, working with an accountant will help here, as we can serve as a neutral third party to help you determine the nest level of personal compensation while still trying to ensure the business remains healthy and has room to grow in the way you are hoping for.
So now you are closer to making a decision. But usually when making big decisions you should look at the pros and cons of each option, so why don’t we do just that next.
Greater flexibility: Rather than needing to pay herself a set amount, Your compensation can fluctuate depending on how her business is performing.
More Flexible Timing: Perhaps an unexpected personal expense leaves you needing access to more cash than usual. If it’s available in your business, an owner’s draw will allow you to access it right away.
Reduced funds: An owner’s draw reduces a business’s equity, which reduces the funds available for future business spending.
Less admin work: Taxes are deducted from your paycheque automatically. Additionally, your compensation as the business owner is a more stable expense, which makes it easier to track your income and expenses.
Cash flow: What happens if your business has a down month? While it’s possible to adjust your salary to give yourself some more wiggle room, figuring out how much to pay yourself at a level your business can sustain can be challenging.
Salaries and draws are both subject to payroll deductions.
Each sole proprietor and partner in a partnership is responsible for paying self-employment taxes on the business’s profits. These business owners pay CPP and EI contributions through the self-employment tax. If a salary is paid instead, the owner receives a T4 and is responsible for deducting CPP and EI taxes from the salary.
Contrarily, shareholders of corporations do not pay self-employment taxes on distributions to owners; nevertheless, owners who work as employees must first be given a fair wage before profits are paid out.
It’s possible to take a very large draw as the business owner. The business owner may pay taxes on his or her share of company earnings and then take a draw that is larger than the current year’s earning share. In fact, an owner can take a draw of all contributions and earnings from prior years.
However, that isn’t without its risks. If the owner’s draw is too large, the business may not have sufficient capital to operate going forward.
Depending on your business structure, you might be able to pay yourself a salary and take an additional payment as a draw, based on profit for the previous year. Make sure you plan carefully to pay your tax liability on time in order to avoid penalties and be payroll compliant.
In addition, to stay organized and payroll compliant, it is recommended to keep payroll records for about six years.
Online payroll services will help you keep your payroll tax documents organized. Choosing the right provider, one that supplies expert support, will be key in assisting with any tax confusion or compliance issues.
Your business entity will be the biggest determining factor in whether you take a salary or draw (or both). For example, if your business is a partnership, you can’t take a salary—you have to take an owner’s draw.
So, make sure that you review the above section on business classifications carefully as that will reveal a lot about the best way to pay yourself as a business owner.
Here are a few other things to consider:
Business funding: You need to leave enough capital in the business to operate, so consider that before you take a draw.
Tax liability: A business owner needs to be very clear about the tax liability incurred, whether the distribution is a salary or a draw. Work with a CPA to plan for your tax liability and any required estimated payments.
Each method generates a tax bill: You’ll pay CPP, EI, and income taxes through each type of business entity. Your decision about a salary or owner’s draw should be based on the capital your business needs and your ability to perform accurate tax planning.
This decision regarding a salary or a draw impacts your business and your personal tax liability.
Need help with this issue, or any other financial question relating to your business? An accountant is one of the best sources of that assistance. Contact us today and let’s talk about how we can help you.