Once you incorporate your business you need to decide which is the best way to pay yourself, a salary, dividends or a mix of both. There are advantages and disadvantages to both salary and dividends for business owners.
- If you are paid a business salary, then you will be paying into the Canada Pension Plan. This is an important consideration for the future as the amount of retirement benefits that you will get depend on how much you have paid in and for how long.
- Your salary or bonus will be a tax deduction for the corporation.
- As well as paying yourself you can also do some income splitting with your spouse or children.
- You will also be able to contribute to RRSP’s or TFSA’s for your retirement.
- You will have a personal income which is fully taxable unlike dividends which are taxed at a lower rate so your tax bill may be greater.
- For the Canada Pension Plan, you will have to pay both portions as you are both an employer and an employee.
- You will have to do payroll and set up a payroll account with the CRA and file all the related paperwork.
- If your business profits vary from year to year, paying yourself a salary will mean that you will not be able to carry back a business loss for future years which you could if you are paid by dividends.
Payment by Dividends
- Dividends are taxed at a lower rate than salaries so you may pay less personal tax.
- Dividends can be declared at any time which means that you can optimize your tax situation.
- Not paying into the CPP will save you money.
- It is easy to pay yourself dividends, you just have to write a cheque to yourself from the company and at the end of the year update the corporation minute book and prepare a director’s resolution for the dividends paid.
- Not paying into CPP will lessen the amount of CPP you are entitled to when you retire.
- Being paid by dividends does not allow you to contribute to an RRSP as you do not have any income and can mean that you cannot claim other personal expenses.
Payment by a Mix of Salary and Dividends
Whether payment in a mix of salary and dividends is the best way to go for a business owner is dependent on their personal circumstances including income level, cash flow needs, and the corporation’s predicted income for the next year. The owner needs to understand if he needs to have room to contribute to his RRSP and if income tax deductions are important. The decision to pay in a mix of salary and dividends should be made after discussions with an accountant or financial planner.
Sometimes a mix of salary and dividends is paid out by the company to ensure that it does not earn over $500,000 as this is the limit up to which a privately-owned company pays the lower rate of income tax. If earnings are greater than this, it can be better to pay the owner a salary thereby reducing the corporate income.
Sole Proprietorships or Partnerships
As these types of businesses are not owned by shareholders, they cannot issue dividends and the owners cannot be salaried employees with payroll deductions. Business income and personal income become the same thing, so you have no choice but to report your earnings on a T1 income tax return.
From an article by Susan Ward