Tax Tip Thursday

Today, we are talking about running payroll for your own small corporation—particularly an Ontario business with fewer than five employees.

At first glance, payroll seems pretty simple. You take an employee’s salary, deduct some tax, CPP and EI, and deposit whatever is left into their bank account.

How hard could it be?

Well, payroll is one of those jobs that is easy when everything goes perfectly—and surprisingly complicated the moment something changes.

The first challenge is simply deciding who is actually an employee.

Small businesses often hire someone and call them an independent contractor because it seems easier. No payroll deductions, no vacation pay and no T4.

Unfortunately, calling someone a contractor does not necessarily make them one. This is an area where guessing is not a good strategy and could cause a LOT of grief!  CRA may consider them an employee. If that happens, your corporation could be responsible for CPP, EI, income-tax deductions, interest and penalties that should have been dealt with from the beginning.

The second complication arises when you put yourself on payroll.

As the owner of an incorporated business, you may be able to compensate yourself with salary, dividends—or a combination of both.

If you pay yourself salary, you cannot simply transfer money from the company to your personal account and decide at year-end that it was payroll. The corporation MUST  calculate the deductions, record the payroll and remit the required amounts MONTHLY throughout the year.

Remember, you are in all likelihood NOT eligible to contribute to or receive EI.  This also applies to immediate family!  This is one of those areas where guessing can create a mess later.

The third complication – payroll remittances

For every pay period, you will need to calculate income tax, the employee’s CPP contribution and the employee’s EI premium. The corporation must also pay the employer’s share of CPP and EI.

That employer portion is easily overlooked when budgeting for a new employee. If someone earns $50,000, the cost to the business is not simply $50,000. There will also be employer CPP, employer EI, vacation pay, statutory holiday pay, WSIB premiums, benefits and other employment costs.

Fourth challenging aspect of payroll is vacation pay.

Vacation pay is another common problem. In Ontario, vacation time and vacation pay are related, but they are not exactly the same thing. You need to know whether vacation pay is being added to each paycheque, accrued for later payment or included in the employee’s salary under a proper agreement.

Simply saying, “Your salary includes vacation pay,” may not be enough if the employment agreement and payroll records do not support it.

Statutory holidays can also cause confusion. Eligibility and holiday-pay calculations do not always produce the amount a business owner expects. Bonuses, commissions, taxable benefits, overtime, unpaid leaves and terminated employees can introduce additional calculations.

Fifth payroll consideration is taxable benefits.

If the corporation pays for something personal—perhaps a company vehicle available for personal use, a flat-rate automobile allowance, certain insurance premiums or a personal expense—that amount may need to be included on the employee’s T4. Running the expense through the corporation does not automatically make it tax-free.

Once payroll is calculated, the deductions must be remitted to the CRA on the corporation’s assigned schedule. Many small employers are regular remitters, with amounts generally due by the 15th of the following month. Some qualifying new small employers may remit quarterly—but you should confirm your assigned frequency rather than assuming.

Remember: the money deducted from an employee’s pay does not belong to the corporation. It is being held for the government. Using payroll deductions to cover temporary cash-flow problems is a particularly dangerous habit because late remittances can produce penalties, interest and potentially personal liability for corporate directors.

Sixth consideration is year end T4

At the end of the calendar year, the corporation must reconcile its payroll records and prepare T4 slips and a T4 Summary. These are generally due by the last day of February following the calendar year.

This is when small errors made throughout the year tend to reveal themselves. Perhaps CPP was calculated incorrectly, the remittances do not agree with the T4 Summary, a taxable benefit was missed or an employee was accidentally treated as exempt from EI.

If an employee leaves, the business may also need to prepare a Record of Employment, issue the final pay and properly calculate outstanding vacation pay. Depending on the circumstances, termination pay or severance obligations may also arise.

In Ontario, you should also determine whether the business must register with WSIB. Coverage depends partly on the industry and the nature of the work. Do not assume that having only one or two employees automatically makes the business exempt.

Employer Health Tax is usually not an immediate concern for a corporation with fewer than five employees because of Ontario’s available payroll exemption—but associated corporations and related employers may have to share that exemption.

So, should a small corporation run its own payroll?

The answer is much the same as the answer to “should I do my own bookkeeping” – if someone understands the rules, as payroll experience and formal training ,uses reliable payroll software and performs regular reconciliations, then you have a better chance of not causing yourself a lot of grief.

Otherwise, you should NOT.

But payroll is not just pressing a button every two weeks. The software will calculate what you tell it to calculate. It will not necessarily tell you that the employee was classified incorrectly, the vacation-pay arrangement is wrong, a benefit is taxable or your shareholder salary was never properly recorded.

My practical advice is this: even if you process payroll yourself, have an accountant or experienced payroll professional review the setup before the first paycheque and reconcile it at least a few times during the year.

Fixing a payroll mistake in March is usually manageable.

Discovering three years of payroll mistakes during a CRA review is considerably less enjoyable—and much more expensive.

Running your own payroll can save money. Just make sure the savings are not eventually mailed to the CRA in the form of penalties and interest.

You can avoid costly payroll mistakes by getting assistance from a professional before you try doing it yourself! Call us at 905 862 2727 to make an appointment or you can google The Mad Accountant and you can make an appointment through my website.  Make An Appointment today!

Disclaimer:

This article provides information of a general nature only. It is only current at the posting date. It is not updated and it may no longer be current. It does not provide legal or tax advice nor can it or should it be relied upon. All tax situations are specific to each individual. If you have specific tax questions you should book an appointment for a 1 on 1 consultation.