T1 vs. T2: Leaving Money in Your Corporation

T1 vs. T2: Leaving Money in Your Corporation

Money | Posted by YouInc.com - June 25, 2014 at 12:15 am
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It’s a common dilemma for the sole shareholder of a small Canadian Controlled Private Corporation. Is it better to pay yourself a salary or leave the money in the company?

The answer, of course, is to consult your tax advisor. A specialized tax preparer, such as an accountant, will be able to provide advice based on your particular situation. Prepare for that conversation by considering the following information.

Corporations are taxed less than individuals

Keeping your salary to a minimum carries certain advantages, according to one accountant.

“If your business qualifies for the Small Business Deduction, meaning it is a Canadian Controlled Private Corporation, carrying–on an active business in Canada, then the 2014 federal corporate tax rate is an attractive 11% on the first $500,000 of net taxable income, plus the applicable provincial rate,” explains Howard Lerner, a partner with accounting firm Richter LLP. “For example, in the province of Ontario, the combined corporate tax rate for 2014 is 15.5%.”

“Whereas drawing a salary may expose your money to a much higher personal tax rate,” warns Lerner. “Again using the Ontario example, you might pay as much as 31.4% (average tax rate) on earnings of $140,000.”

Keeping money inside the corporation may also provide the funds needed for future expansion, or to help ease cash flow crunches. Otherwise you can use the funds for various other business ventures such as purchasing commercial property or starting another business. However, you need to consult your tax advisors to ensure that you protect these investments from potential creditors.

You do need an income

There are benefits to drawing a salary from the company:

  • It demonstrates to a potential buyer that the company can afford to pay its owner.

  • A regular paycheque will help you to maintain a personal credit rating to assist with any future bank financing requirements (such as obtaining a home mortgage).

  • You simply need some cash to meet your living expenses.

“Chances are you’ll do a bit of both,” expects Lerner. “Most business owners leave some money in the company while drawing a modest salary.”

That strategy will require using the following tax returns:

A T1 general tax return

It’s a multi-page document that you may complete on your own using tax software or with the assistance of a paid tax preparation specialist. Most T1 returns contain pages for your provincial and federal tax calculations as well as several schedules (attachments) containing information about specific tax write-offs and tax credits you wish to claim. 

Corporation income tax (T2) return

Every corporation operating in Canada has to file a T2 corporate income tax return even if there is no tax payable or the corporation is inactive.  Your corporation must file that return every year within six months of the end of its fiscal year.

Most corporations can file their return online (it’s mandatory for certain corporations with annual gross revenues exceeding $1 million.) Canada Revenue Agency (CRA) discusses a number of options to prepare and file your returns – worthwhile reading on their website. However you choose to file your return(s), keep all your related receipts and documents for seven years as CRA may want to see them at some point.

For small business owners, tax time can have major financial implications. There are a lot of moving parts to figure out, which is why it may make sense to work with a qualified tax specialist to design the best move for you and your business. Along the way, speak with your Scotiabank Small Business Advisor to explore bank products and services available to support your needs.

(This article is for educational purposes only and should not be considered as advice. Be sure to consult a qualified tax specialist for advice specific to your particular situation.)

What’s your strategy? Please share your comments in the Get Growing For Business Discussion Group on LinkedIn. 

Tags: accounting, get growing for business, scotiabank, taxes, management

Roger Pierce
With Roger’s experience in starting and running 12 small businesses, it’s no wonder that he is Scotiabank’s small business expert. Roger takes what he has learned and shares it with thousands of entrepreneurs worldwide in articles, blogs, videos, and presentations. He’s also co-author of the book, Thriving Solo: How to Grow a Successful Business.
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