Should I Pay Myself Salary or Dividends?
As an incorporated business owner in Canada, you’ve likely had to consider how you will be paying yourself. The type of remuneration you choose will have significant tax implications, so it’s best to have a thorough understanding of your options.
While there are several forms of compensation, the most common include salary, dividends, or a combination of both. Each contains its own advantages and disadvantages. Thus, it can be extremely beneficial to consider effective tax planning early on to determine which form of compensation best meets the unique financial situation and characteristics of your business structure.
Salary
A salary consists of regular compensation received from an employer to an employee for work performed. The employee only receives a percentage of their salary, with the rest going to the Canada Revenue Agency for taxes, employment insurance, and Canada Pension Plan (CPP) contributions. As a separate legal entity, a corporation will deduct the salaries of its employees through its payroll account (RP) when calculating its taxable income for the year.
Advantages
- Beneficial in planning for retirement through CPP contributions;
- Increases the RRSP contribution limit, allowing deferral of taxes;
- Is a form of stable income;
- Has a standard tax period and is declared through an annual T4 form;
- Consistent income can be beneficial for receiving bank loans, credit and mortgages;
- Salaries allow access to specific deductions (e.g., childcare expenses);
- Less likely to receive surprise income tax bills;
- Salaries are considered tax-deductible for your corporation; and
- Taxes are paid to the CRA throughout the year.
Disadvantages
- Personal income is 100% taxable (i.e., you could end up paying more taxes);
- As a business owner and employer, you must set up an RP account with the CRA; and
- As the employer and an employee, you pay CPP twice.
Dividends
Unlike salaries, which are considered personal income, dividends are an investment profit that an individual receives from their ownership of corporate shares. Dividends are paid out of retained earnings, which means the corporation has already paid some taxes before the individual receives the dividend.
For tax purposes, there are three types of dividends – capital, eligible, and non-eligible. Capital dividends are tax-free because they are paid out of the corporation’s Capital Dividend Account (“CDA”). Since only 50 percent of capital gains are taxed, the corporation can pay the remaining 50 percent of capital gains as a tax-free dividend. On the other hand, eligible and non-eligible dividends require the recipient to pay personal tax. Notably, eligible dividends are taxed at a lower rate than non-eligible dividends. This is because the corporation has paid a higher tax rate on eligible dividends, thus the individual gets credit for the higher amount of taxes paid by the corporation.
Advantages
- Saves the corporation money by avoiding mandatory retirement contributions;
- The individual gets credit for the taxes paid by the corporation, which lowers the amount of tax to be paid by that individual;
- Not required to register an RP account and send regular remittances to the CRA;
- Possibility of income splitting;
- Easy distribution with no requirement for the corporation to remit tax on the payment; and
- Is considered “earned income” for specific programs (e.g., maternity leave).
Disadvantages
- Based on the number and class of shareholders, allocation can be challenging;
- Must consider alternative retirement saving plans due to lack of contribution to CPP;
- Does not increase RRSP room; and
- Precludes you from claiming other personal income tax deductions (i.e., childcare costs).
Theoretically, in a flawlessly integrated tax system, there should be no tax advantages for corporations who pay their shareholders through dividends or employees who are paid by salary. The overall corporate and personal taxes paid should be the same. However, despite recent legislative changes in the differences between the two forms of compensation, there are many instances where it can be advantageous to employ one method over the other. Therefore, effective tax planning in the early stages after incorporation can help you keep more money in your pocket. If you have questions about what the right option is for you, give us a call today!
**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.
Jason Rosen
