It comes up in every initial meeting we have with a business owner: the question of salary versus dividends. Both are legitimate ways to draw an income from your corporation, but both have their pros and cons.
There’s 3 main ways to pay yourself as a business owner.
When it comes to paying yourself from the corporation, there are three main methods you can use:
- Dividends
- Paying yourself a salary
- Via a Shareholder loan, which you must repay (to be discussed in a later article)
As a business owner, you can pay yourself from your corporation through a salary, dividends, or a combination of both. The method you choose depends on a variety of business and personal factors. These factors include effects on personal tax, corporate tax, RRSP contribution room, and your eligibility to receive compensation from government programs and benefits. Let’s take a look at the different effects of taking a salary versus dividends in more detail.
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Salary
Benefits: Salary is an expense to the corporation. Therefore, it reduces the corporation’s taxable income, and thus reduces the taxes owed by the corporation. Furthermore, because salary qualifies as personal income, you may be eligible for income tax credits which can include childcare and medical expenses. By taking a salary you will also be contributing to the Canada Pension Plan (CPP), which will provide you more money in retirement. Lastly, a salary is considered earned income and as such taking a salary from the corporation allows you to build RRSP contribution room, whereas dividends do not.
Costs: Taking a salary requires you to report it to the CRA as personal income, which increases the amount you will owe on your personal taxes, as your pay cheques are subject to the personal income tax rate on your overall salary. You are also required to make contributions to the Canada Pension Plan (CPP), and if you own your own business you are required to pay both the employee and employer portion of the CPP contributions. This means you have access to less cash now, but more in retirement.
Dividends
Benefits: Dividends are payments to shareholders of the corporation with after-tax earnings. Dividends are considered investment income rather than personal income. As such, they are subject to the dividend tax credit, which lowers your personal taxes. By taking dividends, you and the corporation will not have to contribute to the CPP; this means you will have more cash now, but less owed to you at retirement.
Costs: Dividends are not considered a corporate expense, and therefore do not lower the corporations’ overall taxable income. As such, by paying dividends, you may pay less tax personally, but the corporation will owe more tax. Additionally, dividends are not considered earned income. RRSP contribution room is calculated based on your earned income and as such you are unable to build RRSP contribution room. Lastly, dividends are not considered salary on loan applications, which may affect your ability to apply for a mortgage or other non-business-related lines of credit.
So, how should you pay yourself as a business owner?
It depends on your circumstances and the makeup of your company and your retirement planning. Dividends offer more flexibility from a personal tax perspective; however, you will need to be careful and strategic when it comes to your retirement savings as you lose the ability to contribute to your RRSP and the CPP. When making this decision it is important to consider your personal circumstances, company structure, and your goals. Connect with your trusted financial advisor to explore which option may be best for you (or a combination of both!).