Salary or Dividend, How Should I Pay Myself?
If you own your own business, you can take money from your corporation in three ways:
- A shareholder loan
- Paying yourself a salary
- A dividend payment
- A Shareholder Loan
A shareholder loan is required to be repaid under Canadian tax laws so this really leaves two alternatives, salary or dividend. Both have their advantages and disadvantages. There are both personal and business factors to consider.
- Paying Yourself a Salary
With a salary or a wage, the payments are a deductible expense of the corporation and thus reduces the amount of taxes the corporation has to pay. The payment is employment income to you. The corporation must issue a T4 to you similar to when you worked for someone else.
If you choose to pay yourself a salary from your corporation, you will need to open a payroll account with the Canada Revenue Agency (CRA). For every salary payment, you will need to withhold and remit income taxes to the CRA. You will also be required to withhold and contribute to the Canada Pension Plan (CPP). The company must also match the CPP being withheld from the salary payment. Assuming that you and or immediate family members own greater than 40% of the voting shares of the company, then you are exempt from Employment Insurance (EI) contributions.
- Paying Yourself a Dividend
Unlike a salary, dividends are not considered a company expense, as they do not lower your company’s taxable income. However, dividends are taxed at a lower rate than a salary to you as an individual. Only company shareholders are eligible to receive dividends. Corporations are required to report dividends paid to shareholders on a T5 slip. This is the same slip you receive from your financial institution reporting interest earned, or dividends received from an investment account. Different from a salary, there is no requirement by the corporation to withhold income tax and remit it to the CRA. Dividends are not subject to CPP or EI.
Dividends are paid based on share ownership and by class of shares. Therefore, if Company A. is looking to pay $100,000 in dividends to the owners of their common shares, it will be paid out based on percentage ownership. If Mr. B owns 20% of the company’s common shares, and Mrs. B owns the rest (80%), Mr. B can expect to receive $20,000, and Mrs. B will receive $80,000. This can make tax and remuneration planning difficult. A simple fix to provide better flexibility, the company could issue, for example, Class A common shares to Mr. B and Class B common shares to Mrs. B.
So Which One do I Choose?
With a salary, taxes are paid throughout the year through the payroll withholdings. With dividends, there are no tax withholdings, so there will be a larger amount due on April 30th. CRA will eventually require you to make quarterly installments, rather than waiting annually to receive their tax dollars.
Salaries are considered earned income and create room to contribute to an RRSP. Dividends do not create RRSP room. Your maximum 2021 RRSP contribution limit is $27,830. You needed earned income of $154,611 in 2020 to create that amount of contribution room.
If both spouses work in the family business and there are significant childcare costs, you may want to pay some salaries to each spouse in order to deduct the childcare expenses. Childcare expenses are not deductible against dividend income.
If your corporation is carrying out Scientific Research and Experimental Development (SRED), tax credits can be obtained from salaries paid to carry out the SRED activities.
If your corporation has a number of tax losses carry forward, it may be a good time to pay yourself a dividend to increase profit to be offset against the losses.
Contributing to the CPP will give you access to CPP disability benefits, should they be required.
In addition, income from sources other than your corporation may be a factor in determining your remuneration strategy. You may need to look at the numbers to determine the best course of action.
As noted above, salaries are subject to mandatory CPP contributions. As a business owner, you are in reality responsible for both the employer and employee portion of the CPP. In 2021, the maximum combined contribution will be $6,332.90 based on a salary of $61,600. For 2021, the maximum monthly amount you could receive as a new recipient starting CPP at age 65 is $1,203.75. In order to obtain the maximum CPP benefit, you need to contribute the maximum to the CPP for 39 years. Based on the current maximum limit, this translates to almost $247,000 over those 39 years. So the question is, could I be better off by saving over $6,000 annually and investing it inside my corporation for retirement? Items to consider in answering this question:
- Am I disciplined enough to invest these funds annually?
- The Frazer Institute indicates that those retiring after 2037 will realize a real rate of return of 2,1% on their CPP contributions.
- Life expectancy. CPP benefits do not run but cease on death. A surviving spouse continues to receive 60% of the benefit.
|– Taxes are paid on each pay period|
– Can create room to contribute to an RRSP
– Can deduct childcare expenses
– SR&ED Credits can be claimed
– Mandatory CPP Contributions will give you access to CPP disability benefits
|– Taxes are paid at the end of the year or by quarterly instalments|
– No RRSP room created
– Cannot deduct childcare expenses
– Consider investing CPP savings to fund retirement
There is no one-size-fits-all when it comes to salary vs dividends. There are a number of issues to consider depending on your personal situation and your investment preferences. I would be happy to discuss your personal situation with you.