As a Canadian small business owner, should you pay yourself entirely through salary, entirely through dividends, or using a combination of the two? The answer, unfortunately, is, “it depends”. In theory, the tax concept of integration says that there should be little to no overall difference in income tax paid when comparing dividend and salary payments of a roughly similar amount. In reality, however, dividends or salaries may be favourable depending on the specific tax legislation in the region where your small business is located.
After this article, you’ll have a better idea about calculating payroll taxes and maximizing the corporation’s revenue, meanwhile also working towards your long-term personal financial goals and understanding where paying out dividends makes sense. Keep in mind that dividends can only be paid to company shareholders and do not apply to regular employees. With that out of the way, let’s start with an overview of what salary is.
Salary
A salary (or wage) is a fixed regular payment, typically made on a monthly or biweekly basis but often expressed as an annual sum or hourly wage, made by an employer to an employee. A salary paid by a company must be recorded as payroll expense by the company and as personal income by the individual receiving salary. The same principle applies when payingyourself a salary through your own company. As such, the company would prepare a T4 (and RL-1 in Quebec) delivered to the employee and to Canada Revenue Agency (CRA) for tax purposes (RL-1 is filed with Revenu Quebec).
Benefits:
1. The corporation’s taxes would decrease because the additional salary expense would drive down the taxable income of the corporation.
2. When drawing a salary from a company, the business owner also need not worry about surprise income tax bills because of the frequent and automatic tax deductions in bi-weekly or monthly payroll deposits. See our partner’s payroll calculator to learn about how payroll software can help ease this process.
3. In addition to tax deductions, there are also CPP (Canada Pension Plan or Quebec Pension Plan QPP in Quebec) deductions that are automatically applied, which allow you to start saving early for retirement without having to think about it.
4. Due to the fact that RRSP contribution room is doled out as an annual
percentage of earned income, business owners who pay themselves with salary are able to benefit from additional RRSP contribution room.
5. Banks love the salary remuneration method. If, in your personal life as a small business owner, you’d like to take out an additional credit product, salaries help you do that because they are an indicator of balanced and sustained cash flows.
Complications:
1. Despite the deductions in taxable income for the corporation, the salary you draw from the business must be reported to the CRA and is subject to the personal income tax rate (which will differ depending on how large the salary is). Often, gross personal taxes are higher than corporate taxes, especially for small businesses.
2. As a small business owner, you have to pay the CPP as both an employer and employee.
3. In order to properly remunerate with salary, you must set up a payroll account with the CRA (and with Revenu Quebec for Quebec corporations). Our accounting software at ReInvestWealth helps you out with all your payroll needs.
Dividends
Dividends can be classified as investment income, as opposed to salaries, which are considered personal income. Remuneration using dividends does not reduce corporate taxes, but it does create less personal tax than salaries. Dividend income is thus taxed by the CRA at a corporate rate, not the personal tax rate. Because dividends are not a form of business expense like salaries, the company will have to complete a T5 (and RL-3 for Quebec) form for each shareholder receiving a dividend to declare the income.
Benefits:
1. The process of paying yourself dividends is much easier than salary. All that you must do is get approval for the dividend according to company bylaws, transfer funds from the company bank account to the business owner’s personal bank account and update the corporation’s books. The CRA has criteria for what constitutes an eligible dividend for corporations in Canada.
2. If you are worried about the frequency of payroll remuneration, fear no more. The remuneration for dividends just involves one annual T5 form.
3. Dividends can be declared at any time! Unlike salary, they do not have to be doled out at bi-weekly or monthly intervals.
4. Money is saved by not paying into the CPP (twice if you are a business owner).
Complications:
1. Dividends are not considered expenses (unlike salary expense) and are therefore subject to corporate taxes, however corporate tax rates are much lower than personal tax rates
2. The more mature/developed the company structure is, the more difficult it becomes to remunerate with dividend payments because of the number of shareholders who would be eligible for dividends
3. It is the responsibility of the business owner to save for their own retirement. Because they are not paying themselves with earned income but rather with dividends, they do not benefit from the RRSP contribution room made available to those remunerated by salary. They also do not contribute to CPP when receiving dividends.
4. Because banks value a source of “steady income”, it will be more difficult to establish a line of credit through dividend remuneration.
Now that we’ve seen the benefits and complications of both salaries and dividends, let’s revisit those tangible differences we mentioned earlier with an actual scenario.
Example
Janice is a small business owner in Ontario during the 2021 fiscal year and is deciding whether to take dividends or salary from her business. If Janice were deciding to remunerate $50,000 in salary, she would pay $12,734 in total taxes, whereas she would pay a combined total of $12,196 if remunerated in dividends at the small business corporate tax rate of 12%.
However, salary would be much more appealing than dividend remuneration if Janice’s business didn’t qualify for the small business deduction and she was forced to pay the 25% corporate tax rate. This would bring her combined tax for dividends to $13,491.
Due to the fact that there are different corporate and personal tax laws in each province and territory and with each new provincial or federal government, optimal allocation of payroll between dividends and salary is not a one-size-fits-all solution. But, with professional help, we can find the payment-structure fit that’s right for you.
For more information on the differences between payroll and dividends, or how accounting software can help your growing small business and save you valuable time and money, book a free appointment with one of our ReInvestWealth accountants.
Written by: Shaan Hooey