Salary Vs. Dividends

The ability to set your own salary is a benefit that draws many Canadians to starting their own business. But it is also a benefit that can lead to confusion and frustration as you try to decide exactly how you can extract funds.

When it comes to paying yourself, there are two options:

Salary – paid out of the corporation’s net income, this is a deductible employment return

Dividend – paid out of the corporation’s after-tax retained earnings, this is an investment return

You can also take a combination of both.

What you choose to take depends entirely on what is important to you. Both salary and dividends have pros and cons, and the tax savings differ depending on what you are looking to get.

Some things to consider if you take a salary:

CPP

When you pay yourself a salary from your company’s net income, you have to also pay into the Canadian Pension Plan. This is calculated as 9.9% of the salary, up to $4,712.40. Half of this is paid by the employer while the other half is paid by the employee. The con of paying yourself a salary is that, as both the employee and the employer, you are responsible for 100% of your contribution to the CPP. This makes taking a salary less appealing for many business owners, though it’s not necessarily a bad thing if retiring on the CPP is important to you.

Taxes

One of the biggest disadvantages of taking a salary is the increase in taxes that you will inevitably face. Because salary is 100% taxable, it’s possible that your corporation’s tax load will increase if you pay yourself a salary.  However, this is not always true if you opt to split your income with your family members which can decrease your taxes paid by shifting your income to a member of your family within a lower tax bracket.

Payroll

You must do payroll if you’re planning to pay yourself a salary. This includes setting up a payroll account with the Canada Revenue Agency and preparing T4 slips. You will likely find yourself filing much more paperwork with this option. This can be time-consuming and costly if you hire a bookkeeper to do it for you.

Some things to consider if you take a dividend:

CPP/RRSP

When you take a dividend, you do not pay into the CPP and you cannot contribute to an RRSP. While this does equal immediate savings, it does not allow for you to adequately plan for your future. For many people this is a small price to pay, and often times they have money invested in stocks or are counting on their business profits to support them in their retirement.

Taxes

Dividends are paid from after-tax corporate profits meaning they are taxed at a lower rate. This also means that, because that money has already been taxed, you will receive a dividend tax credit to ensure that the government is not “double-dipping.” While you are able to split your income with other members of your family taking a salary rather than a dividend, there are more strict rules to follow. With a corporate dividend, there is much more flexibility in regard to the amount that you can split your income with family members.

Less Administration

Very little administrative duties are required to legally authenticate dividend payments. Unlike payroll, which can require monthly fees to maintain payroll, dividends can be issues without much documentation. This saves you both time and money and can make dividends appear more appealing.

What Exactly Is The Difference?

The difference between taking a salary vs. a dividend is small, and the monetary savings are usually not noticeable. Our current tax structure is what many accountants call “full integrated,” which means that the taxes paid are nearly the exact same whether you take a dividend or a salary. The only area that you will save is from not paying into the CPP, which is generally not a huge amount anyways, and it is a payment that you will benefit from later on.

So Which One Should You Choose?

While both options have pros and cons, there is no way of determining which one is “better” than the next. Like we mentioned earlier in the post, which one you choose depends entirely on what is important to you. If you have child day care expenses or if you’d like to top up your CPP, a salary probably makes more sense for you. If you’re not worried about CPP or RRSPs and would prefer to share your profits amongst shareholders (such as husband and wife), taking a dividend, which is currently only taxed at 14.3%, is likely the best option.

If you are having troubles deciding which one is right for you, contact Small Business Tax Accountants today. We can help walk you through the process, listen to your needs and plans, and explain which option is the best one for you and why.