One of the two most misunderstood concepts in the Canadian tax system is that of “tax brackets”.
I have heard from people over the years that they don’t want to work overtime or get a raise because it will put them in a new tax bracket and “the government will just take it all”. This is just false.
While it is true that higher incomes are taxed at higher rates, our progressive tax system is structured so that everyone pays the same amount on their first $25,000 per year – whether that is all you made or it is what you made in one month.
There is no such thing as income that is “under the table”, or in this case “on the table”.
CRA makes it clear that all income earned while you are a resident of Canada must be reported and is taxable (with a few exceptions). This includes the tips received by servers, bartenders, hairdressers, and all sorts of service workers.
If reporting your tips is discussed at work, the most common thought is that you should report your tips as a percentage of your wage. If people are paying 15% on their cheques, the logic goes that if you add an extra 15% on your income, that should cover your tips.
However, that isn’t the way things work.
If you think about it, you will see that is a very poor way to estimate your take-home tips. If you work a 6 hour shift for $15 per hour, your gross pay is $90. 15% of that is $13.50. If you are only making $13 in tips in a night, you would probably call that a bad day.
Realistically, many restaurant workers can collect more in tips than they make in wages in a night.
For the last several years, the CRA has been cracking down on the restaurant industry and arbitrarily assessing tips to employees who don’t report (or significantly under-report) their tip income.
The best way to avoid a major tax bill with penalties and interest is to track your tips. Often, tips on your POS machine are tracked and reported on your T4 by your employer. You can keep track of the cash you bring home each night on a calendar, or a note on your phone, or just on a piece of paper. If you can show that you have put even some effort into reporting an accurate number, you are much less likely to have the CRA make up a much higher number for you.
As Canadians, we are fortunate to live in one of the wealthiest countries in the world. A global study in 2018 found that Calgary is the fourth most “liveable” city in the world with Toronto and Vancouver also in the top 10. However, with that advantage comes the opportunity to share with those who don’t have as much.
We each have a certain amount of social capital – money to support those less fortunate than us. A lot of the time, this money is collected as taxes and administered through a variety of government programs. However, there are also tens of thousands of registered charities in Canada that focus on scientific research, humanitarian relief, community programs, etc. If you take a look, you are guaranteed to find an organization that matches yoru beliefs and values and that does work you find meaningful.
Many people
believe they do not have the funds available to them to donate. While at the
same time, they resent the amount of income tax they pay. There is a simple
answer to both of those concerns.
When you make a
charitable donation to a registered Canadian charity, you can receive federal
and provincial tax credits of up to 50% of the value of the donation. If you
live in Alberta and give $1,000 to a homeless shelter, or a research facility,
or an animal rescue foundation, or a youth sports organization, you will pay up
to $500 less in taxes.
You can choose to personally direct where your social capital is spent instead of giving your money to the government in the form of income taxes and allowing them to make that choice for you through their programs. We all give one way or the other.
You can visit CRA’s website to find out more information about registered charities.
When you have a profitable small corporation, you may wonder if it makes sense to buy or lease a “company car” for yourself. In most cases, we advise against this. Here’s an example:
Let’s say you bought a car on January 1 for $10,000 plus GST. You pay $900 per year for insurance, $2,500 for fuel and maintenance, and $600 for parking. You put 18,000 km on the car in the year – 80% of which is driving for work.
If your company buys the vehicle and pays all the expenses, the total deduction (including CCA or depreciation) will be $5,575. This would save your company $669 in corporate tax.
However, you will also have to take into account that you (the individual) had access to the corporate vehicle and drove it for personal purposes. This would add at least $473 in taxable benefits to your personal tax return. In a 30.5% marginal tax bracket, you will pay $144 in taxes. But with the corporate savings, you are still coming out ahead by $525.
But if you own the car personally and pay all the expenses out of your personal bank account:
The company can then pay you a standard reasonable mileage rate as defined by CRA. For 2018, this would be $7,356 or $883 in corporate tax savings. The best part, is that this reasonable allowance is non-taxable on your personal return, so you keep all the tax savings.
Each situation is different but in most cases, you will save money by purchasing or leasing the vehicle personally. If you have questions about how this would work for you, let us run the numbers for you.
The most common question we get from business owners is “Should I pay myself in dividends or wages?”
Unfortunately, the answer is different for everyone.
The first thing we recommend is to minimize the amount of money you draw out in the first place. The main advantages of incorporating come from accumulating profits in the company account.
Realistically though, everyone has living expenses and needs to pay themselves something so we need to figure out the most tax-friendly way to get some of those profits from the company to the owner. We have seen that many accountants will call all of your draws a dividend, and close the books. This is simple easy and requires very little planning or forethought. While this may be the best strategy for you, there are other options.
What’s the difference?
Dividends are a portion of the profits of the company that are paid to the owners.
Wages paid to employees (including owners) are deductions from the company’s taxable income, resulting in lower profits and a lower corporate tax bill.
Advantages to paying yourself a dividend
No payroll remittances: If you have no employee wages, you will not have to make payments to CRA each month.
No CPP premiums: If you pay yourself wages, you will end up paying an additional 9.9% to CRA for Canada Pension Plan. Dividends are not subject to CPP premiums.
Lower personal tax bill: Since dividends are paid out of after-tax profits, the personal tax liability will be much lower – and can be zero in many cases.
Income splitting: If you have a spouse or adult children who are shareholders of the corporation, dividends can be used to split income between members of the household. If each shareholder owns a separate class of shares, the dividends can be paid in any amount to each person.
Note: The federal government is looking into ways to limit this “dividend sprinkling” but for now it is still a viable option.
Advantages to paying yourself a salary
Lower corporate tax bill: Since wages are directly deducted from corporate profits, the corporation will save in federal and provincial taxes.
Future CPP benefits: Since you are paying the CPP benefits on your wages now, you will be building up the CPP benefits you will ultimately receive on retirement.
RRSP contribution room: In addition to increasing CPP benefits, your wages build up RRSP contribution room which allows you even more options to save for retirement.
Childcare expenses: If you pay for childcare, these expenses can be deducted from wages but not dividends.
Increased government benefits: The way dividends are reported on your tax return artificially inflates your Net Income line. This number is used to calculate the GST Credit, Canada Child Benefit, Old Age Security, and many other benefits. So, if you report your draws as wages, you may also qualify for larger benefit cheques.
Conclusion
The answer is different for each person. We can plan your compensation for your current and future needs and make sure that you are paying keeping more money in your hands instead of going to CRA.
The most common question we get from business owners is “Should I pay myself in dividends or wages?”