As a business owner, one of the key things to consider is how you are going to pay yourself. Deciding between paying yourself a salary or receiving dividends can be difficult. There is a common misconception that dividends are always subject to lower tax rates as they are investment income, not ‘earned’ income. However, the concept of integration states that salaries and dividends should yield similar tax results. So, which is the best choice for you? Read our blog on the key differences between salaries and dividends to learn a little more about the subject. At Gallo LLP, our team of expert accountants would be happy to help you decide the most advantageous way to pay yourself as a business owner.
What is the difference between a salary and dividends?
A salary is the consistent payment received by employees based on their position’s work and services provided to the employer. Dividends are the distribution of a company’s after-tax retained earnings to its shareholders.
Salaries are deducted for tax purposes by the corporation; whereas dividends are not.
Salaries are pensionable earnings, meaning Pension Plans (CPP) have to be calculated and remitted on salaries, while dividends are not pensionable earnings (they do not contribute to your pension) so they aren’t subject to CPP deductions.
Salaries are used for calculating the annual deduction limit of a Registered Retirement Savings Plan (RRSP). Because dividends are not considered earned income, they do not increase an individual’s RRSP deduction limit.
Personal tax (and CPP) are withheld by the employer and remitted to the Canada Revenue Agency on behalf of the employee, but dividends are not subject to withholdings, so any earned income and the respective tax liability lies with the individual, rather than the company. Dividends to spouses and children can be subject to Tax on Split Income (TOSI) rules, whereas reasonable salaries are not subject to TOSI.
What are the advantages of a salary?
Salaries are often considered to have many advantages. When you receive a salary, taxes (and CPP) are withheld and paid to the CRA throughout the year, meaning that less tax and/or installments are required to be paid personally in April of the following year. This, generally, makes your tax burden easier to deal with. Another advantage salaries provide is that they build room in your RRSP so you can contribute more.
Salaries require the payment of CPP by the company and employee, meaning that you will receive a government pension when you retire. Some may not view this as an advantage, but most accountants generally believe that this is an advantage to have. Payment through a salary also provides access to certain personal income tax deductions, such as childcare expenses. If you have any questions about the kinds of advantages you receive from a salary, or want to know about personal tax deductions you have access to, our team would be happy to help.
What are the disadvantages of a salary?
Although salaries come with many advantages, there are also a few disadvantages. When tax and CPP is withheld from a salary, along with remitting these amounts and the preparation and filing of annual T4s, it can add up to a large administrative burden of operating a corporation. If you have a smaller company, these burdens can be difficult to manage. From the individual’s perspective, some people believe that there are more efficient retirement savings options available than contributing to CPP.
What are the advantages of dividends?
Dividends can also be an advantageous way to receive an income as a business owner. When you receive dividends, there are no withholdings of tax or CPP to remit to CRA, which can reduce the administrative burden of running a business, making paying yourself as a business owner a much easier process. Depending on the taxable income levels of the corporation, there also may be a slight tax savings by declaring dividends over pay salaries. CPP is not calculated on dividends, allowing those funds to be deployed by the company in different ways.
What are the disadvantages of dividends?
Dividends are not considered earned income and therefore do not contribute to an individual’s RRSP contribution limit. If you’re planning to use RRSPs to save for retirement, exclusively receiving dividends can make this difficult. In addition, since there is no tax withholding requirements on dividends, taxes owed on the investment income you receive from dividends are due April 30 the following year. This can cause cash flow issues if the taxes owed were not planned and accounted for during the year.
Can you receive a combination of dividends and a salary?
Individuals can be compensated using a combination of a salary and dividends. This is often considered one of the most optimal scenarios for how to pay yourself as if creates less administrative burden on the corporation, as well as allows individuals to utilize a combined income process.
What’s better? Salary vs Dividends
When it comes to paying yourself, there’s no one-size-fits-all approach. The best choice for remuneration depends on a variety of factors, and these factors are different for everyone. Here at Gallo LLP, we take a holistic approach and look at every client’s current life situation, family, future goals, and other financial and non-financial factors to help determine the best remuneration types and amounts. We offer sound advice based on each individual client’s needs and goals, and we never provide cookie cutter advice. Our attention to detail and willingness to do whatever it takes to get the best possible financial outcome is what sets our team apart. If you need assistance in financial planning and remuneration for your business, please contact us!