Should I Pay Myself Salary or Dividends from My Corporation?

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A comprehensive guide in this article is discussed for Canadian business owners facing decisions of whether to take dividends or salary from their corporation. In this article, the tax implications, benefits, legal considerations, and financial goals associated with each compensation method are discussed for entrepreneurs to make informed decisions. 

Is it better to pay yourself a salary or dividends?

Being an owner of a Canadian small commercial enterprise employer, one among your first actions is to decide whether or not you ought to pay yourself a salary earnings or dividends – or each. However, this desire will vary relying on how your business is structured. It requires you to have an objective understanding of the pros and cons of each price method.

Industry Norms and Trends 

Different industries have unique compensation strategies and practices. For instance, the tech industry may additionally offer high salaries, bonuses, and fairness compensation, at the same time as the healthcare enterprise may provide comprehensive advantages programs. It's critical to maintain a watch on compensation trends and changes in tax legal guidelines, as they are able to impact the effectiveness of a employer's reimbursement strategy. Companies are more and more offering extra flexible paintings arrangements and that specialize in equity repayment and complete blessings applications.

Pros and Cons of Paying Yourself in Salary vs Dividends

In a business setting, individuals can choose to pay themselves through salary or dividends, each with its unique benefits and drawbacks.

Advantages of Salary:

  1. Salary builds Registered Retirement Savings Plan (RRSP) room, enabling you to make tax-reducing contributions.
  2. A steady salary can aid in qualifying for financial services like mortgages or lines of credit.
  3. Salary also contributes to the Canada Pension Plan (CPP), providing retirement benefits from age 60.
  4. The amounts paid as salary and bonuses are tax-deductible for the business.
  5. Salaries are immune to Canada Revenue Agency (CRA) claims on unpaid corporate income tax.

Disadvantages of Salary:

  1. Paying a salary requires an account with the CRA and associated paperwork, leading to administrative burdens.
  2. Paying into a retirement plan effectively doubles tax responsibilities.
  3. More taxes are typically owed due to higher tax rates on salaries.

Advantages of Dividends:

  1. Dividends enjoy a lower tax rate than salary, with the first $40,000 of dividends being tax-free.
  2. Dividends are not subject to CPP, reducing corporate and personal costs and administrative burdens.
  3. Paying dividends is less administratively cumbersome as it does not necessitate payroll registration and remittances.
  4. The only regular obligation with dividends is the annual filing of T5s.

Disadvantages of Dividends:

  1. Dividends are not eligible for CPP as they aren't classified as "earned income."
  2. Dividends can limit personal tax deductions for expenses such as child care.

The choice between salary and dividends depends on the specific needs and circumstances of the individual and the business.

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.  In the end, you must keep your documents to a bookkeeper to be in safe hands.

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.  

Business Owner's Financial Goals 

The compensation strategy chosen by a business owner should align with their short-term and long-term financial goals. Salary as a stable income is more appropriate for family support or debt repayment. However, dividends are a better option if it Is to minimize tax liability and reinvest in the business.

Cash flow considerations are also crucial; paying a salary demands consistent cash flow, while dividends can be paid as desired. It is important to evaluate the business's financial stability and the impact of the chosen compensation strategy on cash flow.

Lastly, the compensation strategy can significantly influence retirement and estate planning. Contributing to the Canada Pension Plan (CPP) and Registered Retirement Savings Plans (RRSPs) through a salary can help secure one's retirement, whereas dividends do not provide the same advantages.

Legal and Compliance Considerations 

The dividend declaration process requires the following proper legal procedures, which include declaring dividends through a formal resolution and updating corporate records accordingly. If the corporation has multiple shareholders, the shareholder agreement may outline terms and conditions for paying dividends; thus, it is crucial to ensure that the compensation strategy complies with this agreement to avoid potential disputes. Additionally, accurate and up-to-date corporate record-keeping is vital for tax compliance and legal reasons, so the compensation strategy should be thoroughly documented and reflected in the corporation's records.

Impact on Business Valuation 

The impact of compensation strategy on a corporation's records includes reflecting the chosen strategy in financial statements and tax returns. Compensation strategy also affects business valuation metrics such as EBITDA, P/E ratios, and ROE. Higher salary expenses can reduce EBITDA, whereas a higher dividend payout may increase the P/E ratio but reduce retained earnings and lower the ROE

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.

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.

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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.

Written By:
Salman Rundhawa
Salman Rundhawa is the founder of Filing Taxes. Salman provides valuable tax planning, accounting, and income tax preparation services in Toronto, Mississauga, Oakville, and Hamilton.

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