Should you pay yourself a salary or dividends? Watch out for tax consequences!
If you own a small business in Canada, one of the important decisions you must make is how to withdraw funds from the company to pay your personal living expenses. The two main options are to give yourself a salary or declare dividends. Or you can do a combination of both. In this post, we’ll consider the pros and cons of each.
First of all, we’re assuming that your business is a corporation. If you run a sole proprietorship, you must automatically declare your business income on your personal income tax return. You take it as a salary – there is no dividend option.
Let’s look at the two options for a corporation:
Salary
Like any other employee in Canada, you can receive a regular salary from the corporation. With each paycheque, you deduct the Canada Pension Plan contribution and income tax owing. In addition, the corporation must match your CPP contribution.
You have to set up a Canada Revenue Agency payroll account and submit payments on a regular basis. It is very important that these funds be sent on time. Due to the hefty penalties if you make a mistake, we highly recommend that you outsource payroll services. We’ve covered this topic here.
Salary Pros and Cons
Pro: You can pay your spouse or children a salary provided they work in the business. This income splitting may allow you to reduce your income to a lower tax bracket.
Pro and Con: With a salary, you must make CPP contributions. This is a con since it reduces your disposable income. However, it’s also a pro because it builds your CPP account so that when you retire you will be paid a larger monthly amount.
Pro: The corporation can claim salaries and benefits paid as a deductible expense. This will reduce the corporate tax payable.
Dividends
Instead of paying a salary, your corporation can declare a dividend. You simply issue a cheque for the amount. You can choose to declare dividends monthly or on an occasional basis when you need cash.
Dividend pros and cons
Pro: Dividends are taxed at a lower rate than salary so you may pay less personal tax. Canadian controlled private corporations are eligible for a $500,000 small business deduction that reduces tax payable.
Con: You cannot contribute to the Canada Pension Plan. In addition, since you don’t have earned income you wouldn’t be eligible to put money into an RRSP.
Con: When you pay a dividend, you must distribute it based on share ownership. For example, let’s say you own 80 percent of the shares of the company and your spouse holds 20 percent. You must pay the dividend accordingly – and can’t do income splitting by making it 50/50 as you could with a salary.
Con: With a dividend, you may not be able to claim deductions such as childcare expenses since these are based on employment income.
Con: When you pay a dividend, there are no deductions for income tax. This means that you may face a tax bill upon filing your tax return.
Pro: Dividends involve less CRA paperwork than salaries. At the end of the year, you simply issue a T5 slip showing the total amount that the company has paid. As we have indicated above, paying a salary requires you to remit source deductions regularly and on time – or face big penalties.
Con: If you are applying for a mortgage, banks may consider dividend income to be less reliable than a salary. So, you may have trouble getting approval.
Paying both salary and dividends
For many business owners, a mix of salary and dividends may be the best option. You can pay yourself a regular salary to take advantage of the CPP and tax breaks. At the end of the year, you can declare a dividend to claim the small business deduction.
Everyone’s situation is different. At Scalability, we’d be glad to help you determine the best way to withdraw money from your business. You can get in touch with us at support@scalability.ca
.