How to Draw Money from Your Business
There are several ways to draw money from your company, and they each have different consequences and advantages when it comes to tax planning and optimization.
Drawing money from your company can be done through:
When you take a salary, the company manages your income tax deductions before you receive your income, and it is not taxed further afterwards. When paying yourself or your spouse or children a salary, you must be able to demonstrate that the salary is reasonable given the work performed.
Dividends are paid from the company’s earnings after corporate tax is paid and can be paid only to company shareholders.
Tax rates are structured so that whether you pay yourself a salary or dividends, you will ultimately end up with roughly, within 1 or 2 %, the same amount after paying all taxes. However, a big difference between the two options is that dividends offer the deferral of tax and the subsequent growth in investments achieved through the power of compounding. Income splitting is another factor that should be considered when deciding between salaries and dividends.
- Shareholder Loan
As a shareholder in your company, you can take out a loan from the company. This is useful if there’s excess cash in the business and the money is only needed temporarily. The loan needs to be repaid including a reasonable interest rate by the end of the next fiscal year.
- Capital Gains
Capital gains are any profit made by selling a capital or passive asset, like shares in your business, stocks, land, or the business itself. Only 50% of the capital gain is taxed. In order to have capital gains, a transaction must take place.
Pipeline Tax Strategy for Business Owners | Withdrawing Capital Gains
A pipeline is a tax strategy that allows you to extract money through a capital gain rather than a dividend, ultimately saving you between 10-18% in tax depending on your tax rates. In order to utilize a pipeline tax strategy, a transaction must take place. Work with your accountant and lawyer to navigate and ensure compliance with all applicable tax rules and laws.
Since a transaction is required for a capital gain to exist, at least two different parties need to be involved. To accomplish this, a holding company can be created for your company to transact with. With a holding company in place, shares can be sold from one party to the other to create the capital gain.
When Does a Pipeline Make Sense?
Given the administrative work that goes into a pipeline strategy, and the professional services of a lawyer and accountant to help guide the process, a pipeline strategy makes sense for business owners who draw a lot of money from their company. If you will be drawing more than $200K from your company, this strategy may be advantageous to you.
A pipeline strategy also makes sense if you want to withdraw a lot of retained earnings from your company over a short period of time.
Pipeline Tax Strategy Help
For guidance on the best way to withdraw money from your company, book a consultation with us!
KWB Accountants & Advisors will help you simplify your accounting, improve your profit, and achieve your goals by working with you ON your business.