Tax-effective methods for building wealth
As a small business owner, your focus is probably on growing your business as a means to wealth. But that doesn’t mean you—and your business—won’t benefit from using often overlooked tax-effective methods for building your personal wealth using the proceeds of your ongoing business activities. You’ll enhance your company’s cash flow and leave yourself with significantly enhanced retirement savings. Here are a few strategies that you can consider. Discuss them with your financial advisor, accountant and lawyer to see if any of them are right for you.
Revamp Your Corporate Structure
As your business prospers, reorganizing can often reap significant tax savings and help you save more for retirement. This may involve setting up both an operating company as well as a holding company, used to store retained profits. A family trust is also often a useful addition. A trust allows creditor protection of assets, gives you the option of splitting income amongst family members without giving up any ownership, and offers the possibility of earning separate capital gains exemptions for multiple beneficiaries. Your lawyer can help you determine the best corporate structure for you and your family.
Qualify for the Low Small Business Tax Rate
In most provinces, small businesses with an annual pre-tax income of $500,000 or less pay a significantly lower rate of tax than regular corporations. (In some provinces, the lower tax rate only applies if pre-tax income is $400,000 of less.) Time your expenses, investments, and—where possible—income, in order to keep your operation’s annual taxable income below the ceiling.
Think of the Dividends
Rather than just a salary, consider receiving part of your pay in dividends. This allows for greater freedom in determining the income split between you and your spouse. It also saves on CPP premiums, a valuable benefit, since as an entrepreneur you have to pay both the employer’s and the employee’s share of contributions. Dividends also offer more flexibility in terms of when to receive payments.
Consider a Higher Salary
You may regularly only pay yourself what you need for living expenses in order to minimize personal taxes. However, paying yourself a larger salary can actually have two valuable benefits:
• More RRSP Room: The higher your salary, the more you can contribute to a Registered Retirement Savings Plan. Currently, the salary required to put the largest allowable amount into an RRSP each year is about $122,000.
• Lower Business Taxes: Boosting your salary can help reduce your corporate income below the $500,000 small business threshold, meaning you’ll enjoy a substantially lower tax rate.
Talk with your accountant about whether this strategy will lower your net taxes.
Use a Tax-Free Savings Account
If you have money left over after maximizing your RRSP contributions, put money into a Tax-Free Savings Account. Recently introduced, you can contribute up to $5,000 a year into a TFSA. Unlike an RRSP, your contributions aren’t tax-deductible.
However, there is no tax on any profits you earn inside these accounts, regardless of whether it’s in the form of interest, dividends, or capital gains. And there is no tax due on any money withdrawn from a TFSA, including both your original contributions as well as gains earned inside the plan.
Taken alone or in combination, these strategies may help you reduce taxes while investing for the future.