The Salary Question
Hello All,
As we approach the tax filing deadline for T4s (and RL1s in Quebec), I thought it might be useful to (briefly) explore salaries for small business owners, and their implications.
When you’re an employee of a business to whom you are not related, your salary is a representation of the value that you bring to the job that you are doing and is often based on a market rate. If you are a small business owner, you often do not have the luxury of paying yourself a market rate (especially in the early years).
If you are a sole proprietor (unincorporated), many of you will simply take out whatever you can , that is leftover, after you pay your expenses. Since you are taxed on the profits of the business, the amount that you withdraw has no impact from a tax perspective.
Owners of corporations, who take a salary, have to set an amount but this can also vary from month to month depending on how well the business is doing.
Ideally, however, rather than an ad hoc approach of drawing what is available, it can be useful to actually establish think about what your salary should be and pay yourself that amount. One of the ways to determine a fair salary is to assess the market value that you would pay to an independent third party to perform a similar job (of course business owners tend to wear many hats so this can be harder to evaluate, but an approximation will do). Another way would be to calculate your regular living expenses and draw an amount that corresponds to that. It does not have to be extensive exercise, and can also be changed at any time. If you do decide on an amount and your business is doing better than expected, your salary can then be supplemented by a bonus for good performance.
Regardless of how much you decide to pay yourself, it is important to:
a) ensure that you take some remuneration (salary for corporate owners or simply drawings for sole proprietors)
b) pay yourself on a fixed schedule (eg. weekly, biweekly or monthly)
The primary reason you would want to do this is that it gives you a better sense of the costs of running your business and whether your business is actually profitable once you have taken your own salary into consideration. That is why assigning (or withdrawing) an approximation of market value is important.
The second (obvious) reason is that you need to eat, pay rent, save and have some money left over for (at least a little bit) of fun stuff if possible (and if you are a sole proprietor, remember to allocate a portion for taxes)..
Finally, it helps impose financial discipline both on to your business and your personal finances. When you have a fixed amount coming in, you are better able to predict and therefore budget, which can be extremely useful when it comes to taking control of your money and ensuring financial success
Blog Post
Information on Filing T4s/RL-1s and T4As for Small Business Owners
When I was employee, I never really gave much thought to the T4 (and the Quebec equivalent RL-1) process. I knew that sometime around February an envelope would appear on my desk with a tax document
