Paying Yourself 101
As an entrepreneur, one of the top financial decisions you'll likely make is how (and how much) you'll pay yourself. This decision is influenced by various factors, including your business structure, tax obligations, and personal financial goals.
Understanding Owner's Draw vs. Salary
When it comes to paying yourself, entrepreneurs in Canada have two primary options: taking an owner's draw or paying themselves a salary.
Owner's Draw: Also known as a shareholder withdrawal, involves taking money out of the business's profits for personal use. This method is common among sole proprietors, partnerships, and small corporations, where the owner has direct access to the business's funds. While convenient, tracking and documenting owner's draws carefully for tax purposes is essential.
Salary: Business owners may choose to pay themselves a regular salary, just like any other employee. This approach is common among larger corporations and incorporated businesses, where the owner may not have direct access to the business's profits. Paying yourself a salary provides a more structured approach to compensation and helps ensure consistency in your personal income.
Considerations Based on Business Structure
Your business structure plays a significant role in determining how you pay yourself. Here's how it affects your compensation:
Sole Proprietorship: As a sole proprietor, you and your business are considered one and the same for tax purposes. You can take money out of your business as needed, but it's essential to keep personal and business finances separate and track owner's draws for tax reporting purposes.
Partnership: In a partnership, each partner's compensation is determined by the partnership agreement. Partners may take draws from the business's profits based on their ownership stake or receive a salary if specified in the partnership agreement.
Corporation: Incorporated businesses have more flexibility in how they pay their owners. The owners or shareholders can receive compensation through dividends, salaries, or a combination of both. Dividends are distributions of profits to shareholders and are taxed differently from salaries.
Navigating Tax Implications
When deciding how to pay yourself, it's essential to consider the tax implications of your chosen method:
Owner's Draw: Owner's draws are not considered taxable income. Instead, they reduce the owner's equity in the business. However, business profits are subject to personal income tax, so setting aside funds for taxes is crucial.
Salary: Salaries paid to business owners are considered employment income and are subject to income tax, CPP (Canada Pension Plan) contributions, and EI (Employment Insurance) premiums. Business owners must also comply with payroll tax requirements, including remitting source deductions to CRA.
Practical Tips for Paying Yourself
Here are some practical tips for paying yourself as a Canadian business owner:
1. Set a Budget: Determine how much you need to cover your personal expenses and factor this into your business's financial planning.
2. Consult with Professionals: Seek advice from accountants, tax advisors, or financial planners to ensure you're making informed decisions that align with your business and personal financial goals.
3. Document Transactions: Keep accurate records of all owner's draws, salaries, and other transactions to simplify tax reporting and financial management.
4. Check In Regularly: Review your compensation strategy to ensure it remains aligned with your business's financial health and personal financial goals as your business evolves.
Paying yourself involves navigating various considerations, including owner's draw vs. salary and the implications of your business structure. By understanding these factors and seeking professional guidance when needed, you can develop a compensation strategy that supports your business's success and financial well-being.
