Earned Income and Your RRSPs
Hello All,
In honour of Canada day, I thought it would be very exciting to discuss tax concepts that you can then share with your friends and family perhaps at a celebratory barbecue or party (this is particularly effective if you want some alone time:))
The idea of earned income is important largely as it relates to RRSP contribution room and is closely related to active income. RRSPs, as you might know, are the single most effective tax savings vehicle available to Canadians. As such, ideally, you want to maximize the amount that you can contribute each year. This is beneficial, even if you can’t contribute the full amount, as your contribution room is cumulative i.e. anything you don’t contribute gets carried forward to a future year.
So, how do you earn contribution room? Revenue Canada (CRA) calculates this at 18% of earned income. The definition of of earned income according to CRA:
We calculate your earned income by adding your employment earnings, self-employment earnings, and certain other types of income, then subtracting specific employment expenses and business or rental losses.
This means that salaries/wages that you earn as an employee (full time or part time), unincorporated business income, commissions, tips etc. It also includes royalties, research grants and alimony. Interestingly, it also includes net rental income which is usually considered to be passive income in other tax contexts. It does not include investment income such as interest, dividends and capital gains. In other words, income earned on assets (except rental income) does not increase your RRSP contribution room.
Unless you are a business owner, the way in which you earn income is (unfortunately) not flexible. You can’t really ask your employer to pay you dividends instead of salary. Nor can you ask your broker to pay you a salary instead of capital gains.
If you are an incorporated business owner, the most important impact is how you decide to pay yourself (also see my blog post). A salary will be considered to be earned income and will therefore result in RRSP contribution room calculated at 18% of the total salary (up to a maximum of $171,000 of salary or $30,780 of contribution room in 2023). A dividend, on the other hand, does not result in any RRSP contribution room since it considered to be passive investment income (dividends are paid to shareholders while salaries are paid to employees).
I advise everyone to know their RRSP cumulative contribution room as this will allow you to make an informed decision when you do decide to contribute. Even contributing a little can go a long way towards your retirement goals (and reducing your tax bill!).
Survey Request #2:
Thank you to everyone who completed my survey from my last newsletter! I received some incredibly helpful responses. In case some of you didn’t have the time and then promptly forgot about it, here is the link again. The responses will help me improve the focus of my newsletter and perhaps expand what I do here.
Blog Post
My blog post this week addresses many of the questions that I get about salary vs dividends.
Frequently Asked Questions About Salary and Dividends by Owners of Corporations
As an accountant and small business financial consultant, one of the most common areas of confusion and questions by small business corporation owners revolves around how to pay themselves and if one
In The News:
Bank teller Prevents Scam: A bank teller’s concern over an 86 year old client’s request to withdraw a large amount of money led to the arrests of two people
Is it harder for young people to get ahead? Higher house prices, tuition and less generous pensions might be making it harder for the younger generations to accumulate wealth. On the other hand, there is a stronger labour market and greater financial literacy which works in their favour.
Tax Stuff:
Shopify asked to hand over 121,000 business records: Although they plan to fight this, they will likely lose. CRA wants to ensure that those with Shopify storefronts are properly reporting their business income and demonstrates their reach.
How are social media influencers taxed? It shouldn’t come as any surprise that any income you earn as an influencer should be declared as small business/self employment income on schedule T2125. This includes payments received in cryptocurrency. The article is a good read for anyone who isn’t sure or who hasn’t been doing this.
The Grocery Rebate will be issued July 5, 2023:
According to CRA On July 5, 2023, the Grocery Rebate payment will deliver $2.5 billion in financial support to approximately 11 million eligible Canadians and families. In Budget 2023, the Government of Canada introduced the Rebate as a targeted inflation relief measure.
QuickBooks Tip: Recording Dividends
When you borrow or withdraw money from the corporation for any reason, it should be allocated to a shareholder loan account which is a “current liability” on your balance sheet. If you decide to take dividends (rather than repay the loan), then you would reallocate the amount from the shareholder loan account, via a journal entry, to a “dividends paid” account which is part of your equity. The journal entry to reallocate the dividends declared is:
Debit: Dividends Paid (reduction of equity)
Credit: Shareholder Loan (clearing out the loan receivable amount)
Books and Resources:
Coming Soon! Small Business and Your Payroll: If there are any questions that you have about payroll that you want included in the book, please send me an email at ronika@montrealfinancial.ca.
Small Business Tax Facts(Sole Proprietorships/Registered Businesses/Self Employed Workers)
This book helps you take control of your finances by giving you a better understanding of tax (brackets, tax rates, deductions etc), how it applies to your unincorporated small businesses and how to do your own tax return (or at least understand what your accountant does). It also includes a comprehensive breakdown of deductible expenses, by category with special sections on more complex deductions such as home office, vehicle and capital cost allowance.
FastStart Your Corporation(Corporations)
A step by step guide to starting your small business corporation, including what you need to know about incorporation, setting up your accounting and tax considerations.
QuickStart your QuickBooks(Sole Proprietorships and Corporations)
A comprehensive guide that takes you through the many features of QBO and gives you step by step instructions on how to setup and work with QBO day to day. It is ideal for beginners who have never used QBO before and also for those who are currently using it, but have questions or need guidance.
FastStart Your Business (Sole Proprietorships)
A step by step guide for anyone who is planning to start a Canadian business or become self employed (and does not want to incorporate) and wants to know what they need to do or simply has questions.
Small Business and Your Dividends (Corporations)
For incorporated small business owners who want to know more about small business dividends, the differences between salary vs dividends and which is better and step by step instructions on how to file your own dividend declarations (T5s).
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Free Resources
Business 2023 Tax Deadline Calendar
Starting A Corporation Checklist
Start Your Business Checklist
Dividend Declarations Checklist
Small Business Tax Return Checklist
QBO Set Up Checklist.
Small Business Calculators
Previous newsletters
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Wishing everyone a festive Canada Day weekend!
Ronika