My wife, Carolyn, and I attended Lamaze classes leading up to our son Michael's birth five weeks ago.
"Ladies, exercise is good for you," the teacher said. "Walking is especially beneficial. And, gentlemen, it wouldn't hurt you to go walking with her!"
The room fell quiet, so I finally asked: "Is it okay if she carries a golf bag while we walk?"
Carolyn didn't like the idea.
While a pregnant woman shouldn't carry a golf bag, it can be beneficial for your corporation to carry a cash balance. In my last article, (Globe Investor March 1, 2003), I spoke about the benefits of earning active business income in a corporation, and leaving some of those earnings in the company to defer tax. Today I want to talk about what to do with those dollars you've retained in your firm.
It generally makes sense to bring your company's taxable income down to the small-business limit (this has been $200,000 for many years, but increases federally to $225,000 this year, $250,000 in 2004, $275,000 in 2005, and $300,000 after 2005). You see, active business income up to this limit is taxed at a Canada-wide average of just 18.6 per cent.
Most commonly, a company's taxable income is reduced to the appropriate level by paying the owner a bonus at the company's year-end. If you fail to reduce the company's taxable income, you could face a double tax problem on income over the small-business limit. Leaving income under the limit in the company will defer tax, as I showed in my last article.
Once your company's taxable income is down to the small-business limit, you'll likely want to avoid taking more money from your company on a taxable basis because this will end the tax deferral. The objective, then, is to access those dollars in the company on a tax-free or low-tax basis. You can always lend the dollars back to your company if necessary. While there are many things you could do with the cash in your company, here's a list to consider.
Pay salaries to family. If you pay salaries or wages to a family member who has little or no income, the payment will face little or no tax. The pay must be reasonable for the services provided.
Pay tax-free dividends. If a shareholder (perhaps an adult family member) has no other income, it's possible to receive up to $29,280 in dividends from a Canadian company tax free thanks to the dividend tax credit.
Repay shareholder loans. If you've lent money to your company in the past, you can take a repayment of any loans at any time on a tax-free basis.
Pay yourself rent. You may be justified in receiving rent from your company as a landlord where there is space in your home set aside for company business. You'll have to report the rents on your tax return, but may be able to claim deductions against that income to result in no tax owing personally.
Pay a retiring allowance. Too many business owners overlook the opportunity to receive a retiring allowance from the business when it's time to retire. An eligible portion of the retiring allowance can be tax-deferred if transferred to a registered retirement savings plan.
Pay capital dividends. Your company has something called the capital dividend account (CDA). To the extent there is a CDA balance, you can receive tax-free dividends from the company. A CDA balance is commonly created when the company realizes capital gains or receives life insurance proceeds.
Dividend to holding company. If your corporation carries on an active business, it can make sense to pay a tax-free intercorporate dividend to a holding company. This can protect that cash from creditors of the business, and provide flexibility in the timing of income to you.
Purchase life insurance. Consider using surplus cash in the company to purchase a universal life insurance policy with the company as beneficiary. The benefits include: tax-sheltered accumulation inside the policy, tax-free proceeds to the company on your death, and a boost to the company's capital dividend account when insurance proceeds are received (providing an opportunity for tax-free dividends to your estate or heirs).
Consider buying the policy in your holding company (see the previous idea).
Redeem shares for PUC. To the extent you purchased the shares of your company with more than just a nominal amount, you may have paid-up capital (PUC) in those shares. Your shares can then be redeemed and a tax-free return of that paid-up capital can be made to you.
Tim Cestnick, CA, CFP, TEP is author of The Tax Freedom Zone and Winning the Tax Game 2003. He is managing director, Tax Smart Services, at AIC Ltd.
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