You have worked hard to build your business and create a profitable business. During the first few years, you may have stopped paying to reinvest in your business and grow your business. Now you may be at a point where your business has consolidated, and you are ready to start reaping some of the profits from your business. These ways are essential to understand when employing services like small business accounting. This article discusses some of the more general approaches that business owners can use to withdraw money from a business tax-efficient way.
Reward yourself and your family
Business owners will usually pay their wages similarly to rewarding an employee. If family members work in the company, they can receive a reasonable wage (or salary). This is especially beneficial if family members have little or no other source of income. In this case, a “reasonable” wage would be close to what an unrelated third party would be paid for the same job.
Paying taxable dividends
Dividends can be used to distribute corporate money to you and your family members (this however, does not reduce coproate tax). This would require that you, your spouse, and your children own shares in your company directly or indirectly (for example, through a trust or holding company). To ensure this is a tax-efficient method of withdrawing money from a company, it will be important to consider the Distributed Income Tax (TOSI) rules and the company attribution rules before any distributions occur.
Convert “hard ACB” to cash
If you bought your business from someone else, the stock you have acquired might have a “hard” adjusted cost base (ACB), which may become relevant when planning to withdraw cash from your business. “Hard ACB” is basically a tax term representing the amount you paid for the shares when you bought them. They can potentially be converted into cash (or debt that can be repaid later) through a holding company, allowing you to access the capital you have invested, without taxes.
Repay existing shareholder loans
To help finance the startup or growth of your business, you can lend funds to your business in the form of a shareholder loan. Now that your business is profitable, it may be a good time to consider whether the business will repay all or part of this loan. Any amount you receive upon liquidation of your shareholder loan will be a tax-free distribution, similar to a return of equity.
Pay a capital dividend
Another potential untaxed distribution that must be considered is the payment of a dividend from your company’s capital dividend account (CDA). Simply put, a CDA is a notional balance that most often represents a non-taxable portion (currently 50%) of any capital gains (or similar income) that a private company has made by managing capital assets (tangible and intangible).
Frequently Asked Questions
What if my capital dividend account has a very low balance?
If your company currently has no (or very small) board of directors, you may want to consider making an internal sale of the company’s assets that have unrealized capital gains. The launch of these available capital gains will create a CDA, which can then be distributed as a non-taxable capital dividend. Although the tax will be payable on profits within the company, distributing a combination of taxable dividends and equity can be advantageous over simply paying a taxable dividend.
What if I am unable to pay back the company loan?
When accounting for small business and forecasting returns, you might consider paying interest on your shareholder loan. However, keep in mind that while any interest paid would be deductible to the company, it will be taxable to you as investment income. It is also important to note that, in certain circumstances, the TOSI rules will apply to the taxation of interest income received by individuals from private companies with the highest tax rate. Therefore, before paying any interest, it is necessary to assess whether the TOSI rules apply to avoid negative tax consequences.
Can I convert hard ACB into cash from a non-arm length person?
You should be aware that you need to pay attention to where you purchased your company’s stock from a non-independent person, such as a relative. They would apply for V-day protection (for equity properties owned on December 31, 1971) or the exemption from Capital Gains (CGE) on selling these shares to you. This is because ACB’s hard-earned stock does not include the amount of profit made by a non-market member that has been reduced by applying the V-day or CGE rules. If an ACB related to a non-independent person’s V-day protection or a CGE is collected, an alleged dividend could arise.
Is there any opportunity cost related to taking cash out of business?
If you choose to keep income in your company to take advantage of the tax deferral and invest in passive assets, it can increase the passive investment income earned by the company. If so, it will be necessary to consider the impact of the new rules on passive investment income.
What is the tax associated with paying family members?
From a tax perspective, business owners and family members will be taxed on their salary (or wages) at the normal personal marginal tax rates that apply, depending on the jurisdiction in which they live. The Company will be authorized to deduct from the salary (or salary) paid to determine taxable income, but only to the extent that the amounts are reasonable.
If you find yourself in a situation where withdrawing cash from your business is a matter of necessity or obvious, take the time to properly plan how to withdraw money from your business to ensure that you pay the minimum required amount of tax. However, as we have seen, there is no way to get money out of your business in a tax-efficient way.