Small Business Owners - Does salary/RRSP make sense? Here's a case for taking dividends instead of salary.
ABC Corporation has active business income of $112,544 before paying Sue, ABC's manager and sole shareholder. Both Sue and ABC are resident in Ontario. Because Sue has living expenses of $70,000 and wants to maximize her RRSP she takes a salary of $110,000 (after ABC pays its share of CPP premiums in the amount of $2,544), contributes $10,000 to her RRSP leaving taxable income of $100,000 which would attract income tax of $25,198, and CPP premiums of $2,544 deducted from Sue's pay, giving her $72,258 after tax - enough to cover her living expenses and then some. There would be no corporate tax, since ABC can deduct Sue's salary and the CPP premiums that ABC must pay from its taxable income. (ABC must match the CPP premiums deducted from Sue's salary)
What if Sue were to take her money out of the corporation as dividends, rather than salary?
In 2016 the combined federal and Ontario small business corporate tax rate is 15%. So, the corporation would pay $16,882 on the $112,544 of income since dividends are not deductible from ABC's taxable income. That leaves $95,662 to be paid to Sue as a dividend or left in the corporation to be invested. Sue doesn't need all that, so she takes a dividend of $82,500, pays $10,152 in personal tax netting $72,348 - roughly the same amount as she did in the salary/RRSP scenario.
That leaves $13,162 in the corporation which it will invest.
I compared the after-tax numbers assuming that Sue's marginal tax rate in retirement is 30%, and that she earns a 5% rate of return on her investments before tax. Sue was better off by about $7,900 by taking a dividend and having her corporation invest the money, rather than taking a salary and contributing $10,000 to her RRSP, assuming she was going to withdraw the money after 30 years. Note that the $7,900 represents the savings from one year only. Multiply this by the number of years that ABC is in existence before Sue retires.
So, why is it better for Sue take her money out as dividends instead of salary? Two reasons - (1) CPP premiums and (2) Taxation of investment income inside an RRSP vs. outside an RRSP.
CPP - Cost or Investment?
To answer that question I calculated what level of pension CPP premiums would buy using the same 5% rate of return. I did the analysis for someone who turned 18 in 1990, contributed the maximum amount to CPP each year, retired at age 65 and lived to age 90. What I found was that the self-administered pension was more than double compared to the maximum CPP benefits. So this tells me that the CPP is approximately 1/2 cost and 1/2 investment. (To estimate Sue's CPP benefits in the salary/RRSP option, I assumed the amount matched by ABC would be a cost, and the amount deducted from Sue's salary would be an investment.)
Interestingly, when I did the same CPP analysis for someone who turns 65 in 2014, the CPP benefits are very close to the self-administered pension. This highlights the significant increase in premiums relative to benefits over the last 20 years, and, in my opinion, the increases in premiums going forward will be even more significant.
Taxation of Investment Income
I assumed that Sue's marginal tax rate in retirement would be 30%. This is the tax rate that Sue will pay on her RRSP withdrawals. By comparison, if ABC has a balanced portfolio, the majority of the income will be taxed as eligible dividends and capital gains and Sue's tax rate on this income will be just over 11% after Sue withdraws the annual income from her corporation as dividends. She will pay tax of 18% when she withdraws the original investment of $13,162 as a dividend and this was factored into the analysis.
Am I suggesting that all self-employed people should be taking dividends instead of salaries? Absolutely not. One drawback with the dividend option is that it doesn't create any future RRSP contribution room since it's not considered to be "earned income". Earned income is also required to claim child care expenses. Younger people in the higher tax brackets may want to contribute to an RRSP for the immediate tax savings on the assumption that they will likely be in a lower tax bracket when they retire and start making RRSP withdrawals. Also, some private health plans may require some amount of salary to receive certain benefits, though many plans look through to the corporation's income ignoring how the shareholder is compensated. These are some of the factors would have to be considered before deciding on an all-dividend strategy.
In my example, ABC Corporation's income is below $500,000 before paying Sue a salary or dividend. If ABC's income were above $500,000, Sue would normally prefer salary, since the taxation of dividends and corporate income is different at that level.
Classifying your customers could make a real difference to your business. It could be the difference that means you won’t spend every waking hour thinking about it! It could literally improve quality of life for you and your team.
We all have customers we just don’t like to deal with. Well, why do it? Those customers who give us grief, never pay on time, complain consistently, or are generally unfriendly and uncooperative really don’t have to be a part of our lives. These are what we call “D” clients.
The first step, then, is to categorize your customers or clients into A, B, C, and D groupings. First, let’s define an A client. In essence, an A client might be someone who:
B clients might be those who are deficient in one or more of these characteristics. Perhaps they don’t buy as regularly, but they have the potential to become an A. C clients are the same, only to a greater degree. They spend within a minimum range and have very little potential for further development. Finally, D clients are people you simply don’t want to work with anymore.
As such, it becomes important to track your customers’ activities. If you aren’t doing this already, you can begin this process by classifying your customers and tracking their activities from there.
Each client needs to have a profile on your system where relevant information can be stored, including the specific information about their dealings with you.
Information such as special requirements, technical records, the total dollars spent to date, amount spent per contact, averages, and so on can then be recorded in one place. This will help keep a very tight track of each client’s spending pattern. It’s on this record that you register them by their rating—A, B, or C.
When you have those classifications, you have to start doing different things with those groups—and those different things may start with ridding yourself of at least your D clients (if not the C clients, too).
There are lots of reasons WHY you have to do this. You see…
And what’s the biggest reason of all?
It’s simply that D clients don’t fit the profile of people you want to deal with from now on.
Now you might say, ‘No way, we just couldn’t afford to do that!!’ consider another issue, something called Pareto’s Principle.
This suggests that 20% of your customers provide you with 80% of your income. The other 80% of your customers provide you with only 20% of your income.
It is, however, the customers who represent this 20% of your income, who take up 80% of your team’s valuable time! And it’s the 80% that are your C’s, D’s, and possibly B’s.
As such, it simply isn’t worth working with them. Financially, the rewards to the business from these groups are limited, and valuable resources are constantly tied up for little or no return.
If you were to work through your customer list, you’ll probably find this to be the case. Think about those customers who spend the most with you and calculate the income from that group. Compare that, then, to the rest. When you do that, you’ll probably find it’s something close to the 80/20 Rule.
Classifying your clients as A,B,C, or D is critical to building a profitable business.
Here, you have two options.
First, you could develop a system to pass work to others who are more willing to work with that kind of customer. Your competitors will normally be happy to accept your leads.
In fact, you could sell those leads to them. Often competitors are willing to pay you a fee for each one. That way, you can earn some added income to boot and they win a new customer.
(They’ll think like most business owners—any customer is a good customer. Understanding this is not the case will make you more profitable because you’ll have more time to deal with those customers who are more important to your business.)
Second, you could simply fire your client. We have sample scripts to help you do this.
When we say ‘get rid of the D’s, we really mean ‘get rid of the D’s from YOUR workload.’
Go ahead and classify your clients . You’ll be amazed at the insights this gives you.
Taking that one step further, you then use those classifications to manage your customers and your marketing to those customers.
You see, most businesses promote to every customer and potential customer as if they were the same. Needless to say, this is expensive because very often the marketing that would suit an A client would fall on completely deaf ears with a D client.
The classification process you’ve just been through would show you that your A clients deserve (and probably already receive) completely different attention levels than your D (soon to be gone) clients.
Food for thought.
1. What you can measure you can manage. And, what gets measured gets done. If you're not measuring you're not managing.
2. You need to measure the activities, not just the results. Traditional financial statements only show the results of the various activities of your business.
3. Treat your employees the way you would like them to treat your customers.
4. To create a business that really works you need to work ON your business, not IN it.
5. There are just 4 ways to grow a business: (1) Increase the number of customers - of the type you want; (2) Increase the average sale; (3) Increase the transaction frequency; (4) Increase the effectiveness of the process
1. Build a business that works so that you can choose not to.
2. Invest at least 10% of your income.
3. Keep a diversified investment portfolio.
The File Sales Tax feature is a convenient way to gather the numbers required for your GST/HST return. However we have encountered situations with some of our clients where the information was incomplete or inaccurate. We recommend using the Files Sales Tax as a starting point, but make sure the net balance owing agrees to the amount that shows up in your Balance Sheet report (Reports | Company & Financial from the pulldown menu) on the ending date for the GST/HST return.
You are allowed to deduct GST/HST on costs incurred to run your business. These are called Input Tax Credits. However there are some expenses for which you are not allowed to claim 100% of the GST/HST paid to mirror the deduction allowed for income tax. The two main categories are Meals & Entertainment (you can only claim 50%) and Automobile Expenses (you can only claim the percentage used for business). You can set up separate codes on the Sales Tax Code list to handle this automatically when you record these expenses.
As always, feel free to contact us if you need help.
A common misconception is that you can withdraw and re-contribute to a TFSA at will. But the timing of the re-contribution could result in substantial penalties.
Some people are getting caught with a TFSA over-contribution and being assessed penalties by CRA. The penalty for an over-contribution is 1% per month of the over-contribution. So, if you over-contribute by $6,000 for example the penalty is $60 per month or $720 per year. Ouch!
The trap comes when you withdraw funds and then re-contribute. Many were under the impression that you could withdraw and re-contribute anytime you want without penalty. However the rules state that your contribution room is increased in the year following a withdrawal (not the year of the withdrawal).
As an example, suppose you contributed $5,000 in January, 2009 and $5,000 in January, 2010, and withdrew $9,000 in May of 2010. You must wait until January, 2011 to re-contribute the $9,000. If the $9,000 were re-contributed say in July, 2010, you would be assessed a penalty of $540 ($9,000 x 1% per month x 6 months).
We have also learned from CRA that they are assessing over-contribution penalties on amounts transferred between financial institutions if the transfer was not properly flagged (so it looks like a new contribution to CRA). If this applies to you and CRA has assessed a penalty please let us know so we can appeal it.