There is not a week that goes by where we often have to help business owners understand if it makes more sense for them to pay themselves a salary or a dividend through their corporation. If you have a corporation, you have the ability to pay yourself one or the other or a combination of both.
First, What is the Difference?
A dividend is a payment from a corporation using after-tax profits from that company. It can be anywhere from 0- 100% of the after-tax profits of the company, it is up to the board of directors. Dividends are not a corporate expense and therefore cannot reduce corporate taxes. The amount of dividends you receive is proportionate to the amount of equity you own in the company. For example, if you own 20% of a hypothetical company called ABC Co. and your friend owns 80%, any dividend declared you would only receive 20%. So on a $50,000 dividend from the company, you would receive $10,000 and your friend would get $40,000.
A dividend is as simple as transferring cash from your corporate account to your shareholders account but at the end of the year, the company must prepare T5’s for shareholders who have received a dividend.
Why Choose Dividends
By the company electing to pay a dividend, it can be an easy way to withdraw money from their corporation. The following is some key advantages:
- Simplicity – If you were to own 100% of your company, you can just easily declare and pay a dividend to yourself. There is no need to register for payroll and remit source deductions.
- Reduces Chance for Payroll Penalties – By registering for payroll, they usually have to be paid each month and if you are late you will pay penalties.
- Lower Cost – By paying a dividend, you won’t need to contribute to CPP, which in turn will reduce corporate costs. However, this also means you cannot personally contribute to CPP.
Salary/Wages
If a corporation pays a salary or wage, these are now an expense to the corporation as well as employment income for you, and you will receive a T4. The corporation’s taxable income is reduced by the amount of salary/wages that is paid out.
For a corporation to pay out wages, it needs to register a payroll account with the CRA. Each payment, the corporation needs to withhold source deductions (CPP and income tax). At the end of the year the corporation then must file T4’s for any employee that has earned wages.
Why Choose Salary
By paying yourself a salary, you can earn steady income. These are some other advantages to paying a salary:
- RRSP Contribution Room – by paying a salary, you create RRSP room whereas by paying a dividend you do not.
- Applying for a Mortgage – Earning a salary allows the bank to see you are earning steady income, whereas with a dividend they might not see it as such.
- CPP Contributions – Wages allow you to contribute to CPP, dividends do not allow this. However, this is a cost to the corporation.
- Surprise Tax Bill – When paying a wage, income tax is withheld each payment and when you go to file your personal tax return, you will have already paid taxes on this income which means you won’t be surprised by your tax bill. For dividends, there is no tax withheld and it could create a surprise bill.
Which Method Allows me to Pay Less Taxes?
You are probably wondering which method helps me pay less taxes to the government. But it is not so simple. There is a concept called tax integration with the idea that there should be no difference in income tax paid overall (both personal tax and corporate tax) when comparing dividend and wage payments of the exact same amount. For example,
- Receiving a dividend doesn’t reduce corporate taxes, it creates less personal taxes than a salary
- Taking a salary reduces corporate taxes but it creates higher personal taxes than dividends
So either way you take money, the government wants you to pay roughly the same amount.
Calculating Taxes
If you want to see and compare what your taxes would be by taking a dividend or a salary, you can try SimpleTax Calculator to give you an estimate. Or you can always call up your accountant and have him run the calculations (we love doing it).
When considering whether to pay yourself a dividend or salary, there are a lot of moving pieces that you need to consider.
Fortunately, we love talking about this stuff, so give us a shout if you have any questions
