Salary or Dividends? How Corporation Operators Can Pay Themselves Better
If you run an incorporated business, deciding how to pay yourself is a big part of financial planning. The choice usually comes down to salary, dividends, or a mix of both. Each option affects your taxes, retirement savings, and how money moves between your business and your personal finances.
What Is a Salary?
The salary is regular pay from your corporation for the work you do. It counts as “taxable income”, which means your business can deduct it as an expense. This directly impacts your business’ bottom line.
When you take a salary, your corporation must handle payroll. This includes making Canada Pension Plan (“CPP”) contributions and income tax deductions to the government. Salary income also creates contribution room for Registered Retirement Savings Plan (“RRSP”) each year, helping you save for retirement.
Having a salary can make it easier to qualify for loans and mortgages because lenders prefer steady income. The trade-off is more paperwork, including but not limited to, payroll remittances, deductions, and year-end T4 slips.
What Are Dividends?
Dividends are different. They are payments from the corporation’s after-tax profits to shareholders, assuming the owner is a shareholder. They are reported as investment income on personal tax return and can receive preferential tax treatment through the dividend tax credit. Since the company has already paid tax on its profit, dividends do not reduce the business’s taxable income.
Dividends are more flexible than salary. You can pay them whenever the company has extra cash. They are also simpler to handle with no additional deductions required. On your personal tax return, you may qualify for a dividend tax credit that reduces the amount of tax you pay.
However, dividends do not create RRSP room, and you cannot build future CPP benefits. Because dividend income can vary from year to year, lenders may see it as less stable than a regular salary.
Comparing the Tax Side
Salaries and dividends are taxed differently. Salary is deductible for the business and taxed as regular employment income for you. Dividends come from profits that have already been taxed at the corporate level, but personal tax on dividends is reduced to avoid double taxation.
In most cases, the total tax you pay between the company and your personal income is roughly the same for salary and dividends. The differences often come down to timing, provincial tax rates, and personal financial goals.
Other Things to Consider
There are non-tax factors too. Salary builds CPP credits and may help with eligibility for certain government programs or deductions that require earned income. Dividends do not offer those benefits but are much simpler to pay.
Each method also carries administrative obligations. Salaries require payroll remittances and T4 slips, whereas dividends require the issuance of T5 statements at year-end.
Finding the Right Balance
Many business owners use a mix of salary and dividends. A modest salary can create RRSP room, build CPP benefits, and show consistent income. Dividends can then be used for flexibility and to withdraw funds tax-efficiently as needed.
The best balance depends on your business profits, long-term goals, and the province you live in.
A tax professional, such as Rosen and Associates Tax Law, can help you find the most effective combination to suit your situation.
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Disclaimer: This article provides information of a general nature only. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in this article. If you have specific legal questions, you should consult a lawyer.
Bhavika Chadha