Salary vs Dividends: 14 Things You Absolutely Need to Know About Paying Yourself From Your Corporation
Most small business owners know that they can choose between salary vs dividends when paying themselves from their corporation. But you’re not alone if you need more information.
Today, I’ll cover everything you need to know about salary vs dividends.
Table of Contents
- Salary vs dividends: what’s the difference?
- How to pay yourself a salary from your corporation
- How to pay yourself dividends from your corporation
- Why you need to plan how you pay yourself from your corporation
- When to think about paying yourself from your corporation
- Benefits of paying yourself a salary: Tax Perks
- Benefits of paying yourself a salary: Retirement
- Benefits of paying yourself a salary: Buying a Home
- Benefits of paying yourself a dividend
Salary vs Dividends: What’s The Difference?
Businesses pay salaries to compensate people for the work they perform.
Dividends are paid to owners of share capital and are a return on investment.
If you own a corporation and work in that corporation, you get to decide whether the corporation pays you a salary, a dividend, or a combination of the two.
You and your corporation are two separate entities for tax purposes.
If your corporation earns income, it will pay corporate income tax. If you personally earn income, you will pay personal income tax. Usually, the deciding factor between salaries and dividends is the tax you and your corporation will pay.
However, the government strives to eliminate differences in taxes between salaries and dividends. It’s equally important to consider other factors like government benefits and your retirement plan.
How to Pay Yourself a Salary From Your Corporation
If you have employees, you know that salaries are an expense of the business.
Wages paid to you as the business owner are also expenses of the business.
That means you can pay yourself and reduce the taxes your business pays. The flip-side of reducing your corporate taxes through salary is that you will pay taxes personally.
Keep in mind that an added expense of paying yourself a wage is the CPP. CPP can add an extra $6,000 to your tax bill but can be critical to your retirement plans.
In some cases, you have the option of enrolling in a limited Employment Insurance plan for business owners.
Just like wages paid to your employees, your corporation needs to withhold tax and CPP from your wages and remit that to the government on time.
The corporation will report your wages on a T4 Return and then include them as income on your personal tax return. Need more information on payroll remittance and filing deadlines? Check out this post on tax filing deadlines.
The key features of salary paid to a business owner:
- Need to file a payroll statement and remit payroll withholdings for every month that you take a salary
- Salary is deductible by the corporation
- Subject to CPP and withholding tax
- Paid to you as an employee, not as a shareholder
- EI is optional
How to Pay Yourself Dividends From Your Corporation
Unlike salaries, dividends are not compensation that you receive for the work you do. When you incorporated your company, you purchased shares of your company and became a shareholder. Dividends are a return on your investment in your corporation. Dividends are paid to you because you’re a shareholder, not because you’re an employee.
Unlike salaries, dividends are not deductible by the corporation. Your company pays tax on its net income, and you pay tax again on the dividends when you receive them.
Paying tax twice may sound like a penalty, but you pay a lower tax rate on dividends than salary. When you combine your corporate tax and personal tax on dividends, you wind up paying tax almost equal to salary.
Unlike salary, you don’t need to withhold taxes or pay CPP on dividends, and you’re not able to pay into EI.
Key takeaways for dividends
- One slip to file
- flexible, you can take them at any time
- No CPP and withholding tax
- Paid to you as a shareholder of the corporation
- No EI
Why You Need to Plan How You Pay Yourself From Your Corporation
Avoiding tax surprises is the number one reason to plan how to pay yourself from your company.
If you’re taking cash out of the company throughout the year without thinking about the tax, you will wind up with a surprise tax bill. Whether you choose salary vs dividends will impact the size of that bill and when it is due.
In most cases, that cash is long gone by the time you need to pay your taxes.
Planning for your tax bill leads into cash flow planning.
Yes, taxes will take a big chunk of your earnings, and it’s essential to prepare for this.
However, it’s necessary to think about your overall cash needs, too.
Your business cashflow must connect to your personal cash flow. That can include things like your monthly budget for living, big purchases like a vehicle or home and your plans for retirement.
Planning for cash flow is critical to retirement planning. Whether your corporation pays you salary vs dividends, both can have an impact on your retirement. It’s essential to make sure that your current compensation is in line with your plans.
When to Think About Paying Yourself From Your Corporation
I’m in favour of having regular conversations with my clients about how to pay themselves from their company. I like to start with a long-term plan for retirement and how they think it will proceed.
I want to review compensation annually (at a minimum) to ensure that the current plan still works for your household budget, retirement plans or any upcoming purchases like a new vehicle or home or investment.
Benefits of Paying Yourself a Salary: Tax Perks
Most small business owners focus solely on their net cash from the corporation when choosing between salary vs dividends. However, there are other tax benefits to paying yourself salary.
Child care expenses: To claim child care expenses, you or your spouse need to have “earned income,”.
Earned income means employment or business income.
Dividend income doesn’t qualify. If you have employment income, you may be able to claim $5,000 to $11,000 as a deduction from your income.
Employee allowances: many businesses require travel away from home.
Paying yourself a travel benefit (which is tax-deductible by the corporation and can be non-taxable income to you) means a considerable tax saving.
For example, if you travel ten days a month, your company may be able to pay you a meal allowance of $690/month or $8,300 annually.
If you meet specific criteria, the meal allowance will be a deduction in your company and won’t be included in your personal income. It’s one way to get money out of your company completely tax-free.
Health care spending account: Admittedly, this is a grey area of tax law, so proceed with caution.
As an employee of your company, you may be able to claim medical expenses through a health care spending account.
Instead of claiming the medical expenses on your personal tax return as credits, you claim them as a corporate deduction. If you meet the criteria, the expenses will not be included in your income.
Employee loans: Shareholder-employees may take loans from their corporation to purchase a house or shares in a company.
If you meet the criteria, these loans can be an effective way of using cash available in your company without paying personal tax on it all at once.
Benefits of Paying Yourself a Salary: Retirement
Most small business owners focus solely on net cash from their corporation when choosing between salary vs dividends. However, the type of income you choose can have a large impact on the income you receive in retirement.
RRSP contributions: Another reason to choose salary is having the ability to make RRSP contributions.
Dividends don’t allow you to earn RRSP contribution room, so if your retirement strategy includes RRSPs, dividends are out.
Don’t forget, RRSP contributions are deductible from your income. For example, if you earn a sufficient salary to maximize your RRSP contribution room of $155,000, your tax savings would be approximately $8,000 compared to taking the same income as a dividend.
CPP contributions: Make sure your compensation fits your financial goals and plans.
Clients often tell me they prefer to take dividends since they won’t need to pay into the CPP.
Avoiding CPP can save you around $6,200/year. However, it’s not always that simple.
Is CPP part of your retirement plan? If so, contributing the maximum during your working life ensures that you’ll receive the most when you retire. Right now, the maximum benefit for CPP is $1,000/month, and that will increase according to inflation. There aren’t too many investments you can buy that will give you this kind of guaranteed return.
Benefits of Paying Yourself a Salary: Buying a Home
Planning for the future doesn’t just include retirement. Choosing salary vs dividends can have an impact on your ability to get financing.
Application for a mortgage: In my experience, it’s getting harder for owners of a small business to qualify for mortgages from banks.
I’ve had clients with year over year of income over $150,000, with 50% down, still need to go through third-party financing to buy a house.
Regardless, the consensus seems that it does look a bit better to banks when you have a regular salary from your business rather than dividends.
Benefits of Paying Yourself a Dividend
After all of this, in choosing between salary vs dividends, you might be wondering if dividends ever make sense, and the answer is yes, but not as often as you might think. You might prefer dividends if you:
- Don’t want to contribute to CPP
- Have no interest in contributing to your RRSPs
- You can’t take advantage of any of the tax benefits noted above (and if you can save cash to pay your taxes)
- You need flexibility in your compensation
- Or, your company earns investment income
How do I Pay Myself if I’m a Sole Proprietor?
Since your business isn’t incorporated, you don’t need to worry about your compensation.
All of your business income and expenses go directly on your personal tax return and you don’t need to worry about salary vs dividends. You’ll pay both the employer and employee portion of the CPP.
Have more questions about whether you should incorporate your business? See this space for an upcoming blog post.
Salaries vs Dividends: How Do I Pay My Family Members?
One of the most significant tax benefits to business owners is the potential for income splitting. Income-splitting means that you pay your spouse, kids, or other family members from your corporation rather than hiring employees. You still need to consider whether salary vs dividends makes the most sense.
It allows you to keep more of your business cash in the family, and it also allows you to take advantage of the lower taxes that lower-income family members might pay.
There have always been restrictions on how much salary you can pay your family members, and in recent years, the government has put in new restrictions on paying dividends to family members. This makes it easier to decide between salary vs dividends.
Paying a salary to a family member: As with any employee, the salaries you pay family members must be reasonable for the work they do for your business.
As tempting as it is to pay your college-age kid $75,000/year to do 10 hours a week of filing, it may not hold up as a legitimate expense of the business, and it may not be deductible.
Paying a dividend to a family member: This area is a bit more complicated since paying a dividend to your family member means bringing them on as a shareholder of your company.
Simply issuing shares to them can create unexpected tax liabilities or give them rights in your business that you may not want them to have. If you’re planning on doing this, you definitely need to talk to your accountant.
That said, paying dividends to family members used to be a slam-dunk for income splitting with family members.
Unfortunately, recent tax changes make dividends less attractive for some businesses and family members.
Essentially, unless your business and family members meet specific criteria, the dividends they receive will be taxed at the highest tax rate (around 42% tax). The tax law is too complex to go into this post, but please reach out if you have any questions.
Can I pay myself a salary plus a dividend?
Absolutely! You don’t need to choose between salary vs dividends. It’s common for shareholder-employees to take a regular salary every month and then take a dividend for withdrawals that fall outside their salary.
Remember that dividends don’t have tax withheld at source, so you’ll need to plan to pay extra at tax time.
Anytime you take extra cash from the company is an excellent time to call your accountant to update your tax estimate so they can let you know what you need to pay in personal tax instalments.
How do I calculate my taxes? Simple Tax
Are you looking for a quick way to calculate the difference between salary vs dividends? I recommend Simple Tax. It’s a free online app that you can use to get an estimate of your taxes.
What deadlines do I need to worry about?
Whether your corporation pays you salary vs dividends, it’s essential to consider your tax filing obligations.
You’ll need to report wages on a T4 return and dividends on a T5 return. If you need more information about filing deadlines, check out my post-tax filing deadlines here.
Bottom line recommendation
- Plan your personal cash and business cash
- Decide which mix of salary vs dividends works for you
- Keep it simple and regular
- Get advice from your accountant before paying yourself
Need help planning your compensation? Get in touch with us!