Salary Vs. Dividends

Should I pay myself Salary or Dividends from my Corporation

Salary Vs. Dividends

Should I pay myself Salary or Dividends from my Corporation?

Small business owners who operate their businesses through a corporation at tax year end have to determine if they want to receive year end salary or dividends as remuneration from their corporation.  As a shareholder of your corporation, you can either receive salary or dividends from your corporation. There are various factors that need to be considered while deciding between the two options. We will discuss various advantages and disadvantages of both the options.  

Salary salary   Advantages

  • Salary or Bonus paid out will be tax deductible for your corporation whereas dividends are paid from after – tax corporate profits.
  • You will be able to contribute to RRSP if you withdraw salary from your corporation as RRSP limit is increased based on your earned income each year. Dividends are not considered to be earned income and cannot be relied for RRSP purposes.
  • If you are planning to apply for a mortgage, then salary is the best option as banks provide financing based on your earned income which is salary. Banks verify your income from your personal tax return. Dividends are not considered to be earned income and cannot be relied for mortgage purposes.
  • Tax deductions such as moving expenses & child care expenses can only be used against earned income on your personal tax return. Since Dividends are not considered to be earned income, these deductions can only be use against salary withdrawn from your corporation.
  • By withdrawing a salary, you pay into the Canada Pension Plan(CPP). If you have no other source of retirement income or savings, you should contribute to CPP as this can be an important retirement decision on which you will have to act now. Receiving dividend income is exempt from CPP contributions.
  • If you are paying salary to yourself from your corporation, there are certain tax deductions that can be claimed on your corporate tax return such as tax free car allowance and medical benefits paid for you by the corporation as you are an employee for your corporation. Therefore, if the corporation bears such expenses as tax free car allowance and medical benefits, it’s beneficial to pay yourself a salary so that you do not lose on these corporate tax deductions.
Disadvantages
  • Salaries are 100% taxable unlike dividends which are taxed at a lower tax rate.
  • You will have to contribute both the employer and the employee portion of CPP which is 9.9% (4.95% +4.95%)
  • Salaries require setting up payroll account and monthly payroll remittances to CRA. This increases your accounting cost for preparing related paperwork for payroll and T4 slips at year end.

Dividends dividends-1 Advantages

  • Each shareholder of the corporation can receive approx. $35,000 tax free if you have no other source of income. This works great for income splitting with family members as this amount can be multiplied by the number of shareholders if they have no other source of income. For example, if both the spouses are shareholders of a corporation, then both can receive approx. $35,000 each from their corporation and pay no personal tax on it.
  • If you have planned for your future financial security such as savings built up in real estate investments and other sources of retirement income, then you might as well receive dividends tax free from your corporation and avoid paying CPP.
  • Paying yourself dividends is a simple process. You just write a cheque from your corporation to yourself at the year end, update the minute book and prepare a director's resolution for the dividends paid. There is no need to do monthly paperwork unlike salary.
Disadvantages
  • You cannot contribute to RRSP if you pay yourself dividends .
  • Tax deductions such as moving expenses & child care expenses can only be used against earned income on your personal tax return. Since Dividends are not considered to be earned income, these deductions can only be use against salary withdrawn from your corporation.
Combination of Salary and Dividends To maximize personal and corporate tax deductions, combination of salary and dividends is the best option strategically. Salaries are beneficial to reduce corporation’s income if it exceeds $500,000 and then dividends can be paid out if more income is required.  A Canadian Controlled Private Corporation pays much lower tax rate of 16% up to the income of $500,000. Therefore, it almost always makes sense to pay enough salary to the owner to reduce corporation’s income to the $500,000 level.   However, the "correct" answer to the salary or dividends question is completely dependent on the business owner’s own personal financial circumstances. What is his income level? What are his cash flow needs? What is the corporation's expected income for the year? What are his future financial plans? Are RRSP contributions or tax deductions important? What is the owner’s age?  

Because of this, the salary or dividends decision is best made with professional advice such as that of an accountant and tax experts.At Bajwa CPA Professional Corporation, we can guide you in making this important decision by offering sound tax planning advice based on your situation.We can efficiently prepare your T4 and T5 year end slips and file them with CRA. Contact us today for professional consultation.

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