Nusrat asked:

I am in the process of incorporating (as INC.) my business.I will be the owner and director. (Only 1 at this point.) My business will have a business account with bank. My question is - How will I pay myself (or when I witdraw money from bank for personal use)? As the owner or as director's fees or earning from business?** I am very confused about this point and cannot find any answer. Thank You

Julie King answered:

That is a very good question and an understandable one.

First, options for how you pay yourself isn't so much a question as to whether you are a director or shareholder, but rather how you will pay yourself as a shareholder who also works in / runs the company.

I have not heard of a situation where a cororation with a single shareholder paid that person using director fees, which are designed to cover specific costs for things like attending meetings. While you can double check with an accountant, I also don't see that there would be an advantage to this, as according to PWC, director fees are now taxable at regular income tax rate (see slide 9).

So let me address how you can pay yourself as a shareholder of a corporation.

Here you have two basic choices:

1. Putting yourself on a regular payroll schedule, in which case the company pays you a regular salary and will deduct/remit source deductions to the Canada Revenue Agency (CRA). In this situation any net or surplus profits at year end can be reinvested into the company (this shows up on the balance sheet as equity or retained earnings) or paid out as a bonus; or
2. You can opt to not pay yourself a regular salary and instead take money out in lump sums, which are is also known as shareholder loans. In this situation there are special Canadian tax laws that you need to follow, which are described below.

If the company regularly gives you money outside of a standard payroll, that is considered a shareholder loan. Tax laws require that you clear out your shareholder loans on a regular basis.

The details can get complicated, but essentially if you owe the company money on two consecutive year-ends, you will be required to include the principle portion of the loan as part of you net income. For a small company this approach can result in a large amount of tax owing, which can be difficult to pay — especially if you have allowed it to build over two years

There are two ways to clear out a shareholder loan.

The first is with a bonus. The company declares a bonus at year-end, except instead of paying you the money the amount of the bonus is used to bring your shareholder loan to zero.

Here is an example. Let's assume for simplicity that your company year-end matches the calendar year. So for example if you take drawings of $2000 a month, then at the end of the year you owe the company $24,000. The company would declare a bonus of $24,000 and pay the source deductions, but would not pay you the money. Instead, the bonus would off-set your drawings, to net out to zero.

Note that bonuses are another form of employment earnings and the company will have to deduct the proper source deductions as required by CRA and report the income on your T4. 

The second option is to declare the money you withdrew as a dividend to you as a shareholder.

Making decisions about what the best option is in your situation can have significant cost implications, so it is a good idea to get professional advice on what option (or combination of options) is best for your situation. (An important point for new business owners: spending a bit of money initially can save you money and possible headaches later on.)

Dividends, bonuses and shareholder drawings are explained in much more detail in this ask-the-expert question answered by John R. Mott.

As an aside, don't be afraid to put yourself on a regular salary. Setting up a payroll account with CRA is easy and over the long term it is often easier to manage cash flow this way. There is a free accounting program, WaveAccounting.com, which you can use to get started and the payroll module cost $5 per employee per month. That is very cheap compared to payroll modules in other accounting systems.

If you decide to use an accounting program like Wave Accounting, I would highly recommend you have a bookkeeper or accountant help you get set-up, as setting up the initial list of income and expense accounts, as well as getting your bank account set-up properly, can be very difficult for someone new to accounting, but is very easy for a decent bookkeeper or an accountant. Also, the sooner you get set-up, the less money it will cost you as you won't have to retroactively enter transactions.

If all of this sounds very confusing to you - which is understandable if you are just getting started - I would look for a business support centre in your area. Many regions have them and they often provide free consultations as well as seminars on issues like this. And of course, we do have a variety of other article on money topics on CanadaOne!

If you let me know what city/province you are in I'll check to see if we are aware of a centre in your area.

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