Should I pay myself a salary or dividends from my corporation? A very recurring question that is encountered by accountants in Mississauga and all over Canada. The method you choose to pay yourself from a corporation has an impact on many different things – and not just your personal income tax.
Is it better to pay yourself a salary or dividends?
Being an owner of a Canadian small business corporation, one of your first actions is to determine whether you should pay yourself a salary income or dividends – or both. However, this choice will vary depending on how your business is structured. It requires you to have an objective understanding of the pros and cons of each payment method.
Paying Yourself in Salary
What are the advantages of being a salaried employee?
Salary is considered earned income for RRSP purposes. It means that salary builds RRSP room, allowing you to contribute to an RRSP. RRSP contributions can be used to reduce your taxes. If you want to contribute to your RRSP’s to save for retirement, then salary may be the way to go.
Paying yourself a business salary may favor you when you are attempting to qualify for any financing purpose like applying for a mortgage, borrowing a line of credit, or purchasing a new home. Banks like to see an inflow of steady and predictable income, and a salary or wage can help you achieve that.
Salary encourages forced saving. If you are thinking about having a retirement plan, you should consider paying yourself a business salary. Salary is subject to Canada Pension Plan (CPP) premiums. Paying yourself a business salary means that you will be eligible for the Canada Pension Plan (CPP). With CPP contributions, you can receive pension or retirement benefits as early as age 60.
Salary and bonuses paid are a tax deduction for the business, meaning the business will not be taxed on the amount of the wage.
Salaries are immune from CRA claims on unpaid corporate income tax. If the business owes CRA corporate income taxes, GST, and payroll remittances, the CRA can access and collect unpaid tax from a shareholder for dividends that were paid to shareholders by the company. This rule is in practice to prevent shareholders from inappropriate transfer of assets from business to shareholders, where that business has unpaid tax liabilities.
What are the disadvantages of being a salaried employee?
By choosing to pay yourself a salary, the corporation must open an account with the CRA and file the paperwork which usually comes with a lot of cumbersome administrative duties. The corporation will need to hold back source deductions (CPP and Income Tax) each time you are paid. The corporation must also prepare and file a T4 for any employee that earns wages each year when running employee payroll. This usually incurs an additional administrative cost. You may in fact have to hire an accountant to manage your payroll.
A retirement plan would mean that you are expected to pay double as an employer and employee and may have to pay extra taxes to the government. In short, the biggest downside of a salary is the tax challenges.
Paying Yourself in Dividends
What are the advantages of paying yourself dividends?
The biggest advantage of dividends is that it is a lower tax rate than salary and the first $40,000 of dividends can be received completely tax-free. That’s right you can receive $40,000 of dividends without paying any tax whatsoever personally you can’t do that with salary.
The second major advantage of dividends is it’s not subject to the Canada Pension Plan. By paying yourself dividends, you do not need to contribute to CPP, which means that there will be a reduction in corporate and personal costs and less administrative cost.
By choosing to pay yourself dividends, you do not go through the stress of registering for payrolls and remitting deductions. You can easily declare a dividend and transfer money from the corporation’s account into your personal account and record it in your corporate minute book and file a T5 return.
The only thing you need to worry about in dividend payment is completing and filing T5s on time once a year, unlike salaries and wages where payroll remittances can be a challenge if you aren’t using automated payroll software. Failure to pay on time may come with stiff penalties.
What are the disadvantages of paying yourself dividends?
Dividends are not CPP eligible because the dividend is not counted as “earned income.”. Shareholders will have to contribute independently to prepare for retirement. Paying yourself through dividends will make you ineligible to make contributions to retirement plan agencies.
Claiming other personal tax deductions for expenses may be impossible. For instance, child care expenses can be used to deduct salary, but not dividends.
Salary vs. Dividend: Which is better?
Now that you know the pros and cons of dividends and salary you should consult with your accountant in Mississauga to determine which one fits your circumstances. There’s no right or wrong answer to this question. For instance, if you are applying for a loan maybe you want to go with salary if you are concerned with paying the least amount of tax and don’t want to contribute to the Canada Pension Plan that dividends may be the way to go for you Ultimately when it comes to making this decision, the choice is yours and should be based on your specific circumstances, your company structure, and your goals. However, it is common that business owners will pay themselves a mix of a reasonable salary, with dividend options to get the best of both worlds.
What is the most tax-efficient way to pay yourself?
You must understand that in some situations salary would be the better option in comparison to dividends or vice versa, so there is no one size fits all solution. Hence engaging a professional chartered accountant will ensure that you make the right decision resulting in saving your valuable time and more importantly paying fewer taxes.
If you have any further questions related to the above topic feel free to contact us through our website filingtaxes.ca or reach out at 416-479-8532. Schedule your tax preparation appointment with us and take the first step towards proper management of your finances. Our professional personal tax accountants will make sure to get you the maximum tax refund on your personal tax return.
Dividends provide an opportunity to extract profits in a tax-efficient manner. Dividends are subject to the corporate tax rate hence may yield a marginally lower tax rate than what is usually paid on a salary. Whereas with a salary or a wage, the payments become an expense of the corporation. Classification as a business expense, salary reduces your company’s overall taxable income, which in turn reduces the corporate taxes owing. However, you are subject to the personal income tax rate on your salary which tends to be higher than the corporate tax rate. Given the different opportunities and benefits, each affords, determining to pay yourself a salary vs. dividends from your corporation truly depends on your individual business and personal situations.
For small business owners cash breaths life into their business. The way your business is structured has a huge impact on how you pay yourself. The type of business structure you have influences how you receive your wages, pay taxes, and file taxes. Business owners can pay themselves through dividends, a salary, or a combination of both. Sometimes deciding your business’s budget and figuring out how much to pay yourself is tricky. If you are unsure, it’s better to be safe than sorry. Get an expert opinion from a professional, like an accountant.
Though personal circumstances are different for each small business owner, most find paying themselves a combination of dividends and salary as the most tax-efficient structure of working. This involves the small business owners paying themselves a salary up to the tax-free allowance and subsidizing the rest of their profit via dividends.
Disclaimer: The information provided on this page is intended to provide general information. The information does not consider your personal situation and is not intended to be used without consultation from accounting and financial professionals. Salman Rundhawa and Filing Taxes will not be held liable for any problems that arise from the usage of the information provided on this page.