Paying yourself is one of the most rewarding and most challenging aspects of being a business owner. If you’ve set up a small corporation, you can choose between dividends or wages as your main form of income or have a mix of both.
The type of remuneration you choose has significant tax consequences and can affect your ability to plan for the future. Each approach has advantages and disadvantages, and your situation will play an essential role in which one is best for you. Let’s take a closer look at the difference between a dividend income and a business salary to help choose the right one for your needs.
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Paying Yourself a Salary
There’s no difference between paying an employee’s salary and paying your salary as the business owner in accounting and tax terms. A salary is an employment expense, and you’ll receive a T4 tax form. Since employment expenses reduce a company’s taxable income, paying yourself a salary will reduce the corporate tax you have to pay.
However, since the Canada Revenue Agency (CRA) considers a salary a form of personal income, it will affect how much you pay in personal income tax. Generally, the personal income tax rate is higher than the corporate tax rate, meaning that you’ll end up paying more out of your pocket. At the same time, this income is subject to income tax credits like childcare benefits and medical expense deductions.
An additional future benefit of paying yourself a salary is that you have to contribute to the Canada Pension Plan (CCP), which ensures that you save for the future. If your net income is more than $3,500 per year, you’ll have to pay double the CCP contributions of a regular employee as a business owner. This double payment is because you’re paying both the employee and employer contributions.
As you’re a shareholder, you’re exempt from Employment Insurance (EI) contributions, though this does mean that you won’t receive benefits if your company fails and you find yourself unemployed. Finally, receiving a salary allows you to set up a registered retirement savings plan (RRSP) which is tax-deductible and an excellent way to save for the future.
Pros
Paying yourself a salary comes with all the benefits of having a stable, steady personal income. Some of the main advantages include:
- Regular tax period—no surprise income tax bills
- Having a steady income is an advantage when applying for personal loans, mortgages, or other credit
- You will start saving for the future with mandatory CCP contributions
- You can start building an RRSP
- Salaries are tax-deductible for your corporation
Cons
Unfortunately, receiving a salary also has some downsides that you need to consider:
- 100% taxable personal income means you pay more in taxes overall
- You have to pay the CCP twice—once as an employer and once as an employee
- You have to go through the effort and paperwork of setting up a payroll account with the CRA
- You don’t pay an EI premium, but you’re vulnerable if your company fails
Overall, paying yourself a salary as a business owner means putting off immediate gain for future profits. If you want to save for the future, the CCP payments and the ability to form an RRSP pool are exceptional benefits, though you have to pay more tax even though you can claim more personal income tax deductibles.
If you’re on the payroll, you also get the benefits of company health insurance and employee group benefits. This works best if you have an existing payroll, but you can also take advantage of this by setting up your own payroll account.
Payment in Dividends
Dividends are a form of investment income, as opposed to salaries, which are personal income. The CRA treats dividend income differently from personal income and will tax them at a corporate tax rate.
Since dividends are paid out based on share ownership, they can be a less reliable form of income than a salary. It’s usually not an issue for small business owners, where they’re the only shareholder in the company. Still, the process of paying out dividends can become increasingly complex as your company grows.
Unlike salaries, dividends aren’t a form of business expense, which means that they don’t affect your company’s tax responsibilities. When you receive dividends, you have to complete a T5 tax form declaring the income along with one for every shareholder in the company.
As dividends aren’t a form of personal income, they’re not subject to CCP contributions and don’t contribute to your RRSP pool. The process of issuing dividends is also much simpler than the paperwork associated with a salary. All you need to do is transfer money from your company to your bank account, update the corporation’s minute book and have a director’s resolution for the payment.
Finally, if you struggle with payroll remittances, you may appreciate the lowered pressure of dividends. Instead of facing stiff penalties for late or missed payroll remittances when you forget to pay into your payroll, you just need to fill in an annual T5 form.
Pros
- Paying out dividends is easy, especially if you’re the sole shareholder
- Dividends are subject to corporate tax rates instead of personal tax rates
- You can declare dividends at any time, making them more flexible than an ordinary salary
- You save money by not paying into the CCP
Cons
- Dividends aren’t a company expense and are subject to corporate taxes
- Dividend allocation becomes increasingly complex as the business gets additional shareholders with the same class of shares
- You have to consider alternative ways to prepare for the future since you don’t have CCP or RRSP contributions.
Factors to Consider When Choosing How to Pay Yourself
The Concept of Integration
Integration refers to the concept that there should be almost no difference in overall income tax (including corporate and personal taxes) regardless of payment strategy.
The basic idea is that a salary will incur higher personal tax costs but will lower corporate taxes. Conversely, dividends don’t affect the corporate tax rate but incur lower personal income tax to compensate.
Comparing Tax Implications
While recent legislation has minimized the difference in the overall tax rate, there are still situations where one is less taxed than the other. Some business owners may qualify for higher tax savings due to deductibles, which can influence the personal tax they pay.
The simplest way to compare the two is to run some numbers. Compare the total rate, which includes your personal and corporate taxes, when you pay yourself a business salary vs. the total tax rate from dividends income. If you don’t have the time to do this yourself, get in touch with your accountant to do it for you. It’s well worth the time.
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Income Splitting
A final option is to pay both a small salary and get supplemental dividends to shore up your budget.
A typical strategy is to pay out a salary or bonus to prevent the business from earning over $500,000 per year. Different corporations get taxed differently, and earning more than the limit changes your tax implications. Companies earning a net income under this limit have significantly more favourable corporate taxes.
If the company does less well, you can reduce your salary and pay out more dividends, saving on tax while still qualifying for the advantages of receiving a salary, such as tax credits, CCRP contributions, and paid maternity or parental leave.
Consider Your Current Situation
If tax isn’t a major factor in your decision, what is? It’s important to look at your current situation, both in terms of the business and in your personal life, to identify which method is more advantageous.
For instance, if you’re bad at administrative tasks, managing payroll and filing regular paperwork can be difficult. If you put yourself on the payroll and then miss a payment, you’ll be subject to large penalties and fines. In that case, dividends may be a better option.
On the other hand, if you want to buy a new house, you may want to show off the stability of a regular salary. Banks are much more likely to give favourable interest rates for regular payments than periodic dividends. We also recommend shopping around and comparing companies for the right mortgage solution to take advantage of this steady income.
There are also additional benefits that come with a salary that you’ll lose out on with dividends. The large one is the CCP, but you should also consider maternity or parental benefits, which you can’t get if you’re not on the payroll.
Overall, we recommend dividends for companies with one or two shareholders that want more money now at the expense of future security. The lowered tax rate, flexibility, and ease of dividends make them an excellent option for new entrepreneurs.
However, if you need something more stable or want to start saving for the future, a salary may be a better option. It provides more stability and ensures that you start saving for your retirement at the expense of more money at this particular moment.
The Bottom Line
Ultimately, both salaries and dividends are useful ways of paying yourself as a small business owner. There are so many moving parts that providing a clear, generic answer is impossible. It all comes down to whether you appreciate the freedom and flexibility of dividends or prefer to plan for the future.
The best way to make this decision is to sit down with your accountant, financial planner, or tax lawyer. They understand your business and finances and will help you compare tax implications as well as provide advice on which one they’d recommend.
Owning your own business can be a challenge, especially when trying to reduce costs and maximizing profit. One great way of reducing costs is to look for the best group insurance benefits, especially if you decide to pay yourself a salary.
At Group Enroll, we can help you compare group insurance products, such as a Health Care Spending Account, to help you save on your taxes while covering your medical needs at the same time.
No matter what your payment plan, we can help you find the right group insurance products for your small business. Request a quote today and see how much you can save! You can also email us at hello@groupenroll.ca, or we can be contacted by mail at 10 Great Gulf Drive, Unit 5, Vaughan, ON, L4K 5W1.