If you are a owner of small business corporation in Canada, one of the first step is to determine whether you want to pay yourself a salary income or dividends or both. Read below to understand how a Chartered Professional Accountant explains these two income streams and which one to choose for your benefit:
The type of income, whether it be salary or dividends, that an business owner decides to draw from their business will have an impact on both the owner and their corporation.
Types of income from your business
As a owner or employee of the business in Canada, you have the flexibility of paying yourself in the form of salary, dividend or a combination of both. The tax treatment of salary and dividend income is different at both the personal and corporate level. The correct decision for you comes down to personal circumstances, you should have an fair understanding of the advantages and disadvantages of each payment method.
Salary
If you are paying yourself a salary or wage, you are considered an employee of the corporation as such the payments become employment income for you personally - you’ll get a T4. The salary paid to you become an expense of the corporation which reduces the corporation’s taxable income which reduces corporate taxes owing.
How To Pay Yourself Salary
Your corporation needs to be registered for a payroll account with CRA to pay yourself salary. Each time you are paid, the corporation will need to withhold source deductions (CPP, EI and Income Tax) from your pay. These source deductions are then remitted to the Canada Revenue Agency (CRA) on a regular basis. In addition, each year the corporation must prepare and file T4s for any employees that earned wages.
Paying yourself in the form of salary comes with these set of advantages:
CPP Contributions - When you pay yourself salary, it allows you to contribute to the Canada Pension Plan (dividends do not). This means you will benefit in the future when you collect CPP, but it also means that the CPP contributions are a cost for you and for the corporation.
RRSP Contribution Room - If you want to save funds for retirement then paying yourself a wage will allow you to build RRSP contribution room.
Fewer Tax Bill Surprises - Wages allow you to withhold income tax from each payment and remitted to the CRA. When you file your personal tax return you will have already paid income tax and may be eligible for a refund. However, when paying dividends, you do not withhold any income tax and therefore, nothing is remitted to CRA throughout the year, which often creates personal taxes owing in April.
Easier to Borrow Money - If you are looking to purchase a home or property and applying for a mortgage, banks often prefer that you have a steady income (Salary), whereas dividend income may not have you qualify for that bank loan.
Dividends
Dividends are treated differently than wages. Dividends are payments to shareholders of a corporation that are paid from the after tax earnings of the company. This means that unlike salary, dividends are not a corporate expense and do not reduce the corporate taxes paid. The other side is that dividends are taxed at lower tax rate which means they carry less personal tax liability than salary - thanks to the dividend tax credit.
How To Pay Yourself Dividends
Paying yourself dividends is fairly easier than paying salary. As a owner/shareholder of a corporation, you declare dividends and cash is transferred from the corporate/business account to a shareholder’s personal account in one or many transactions. You do not need to register for a payroll account with CRA and you do not need to submit income tax to CRA when dividend payments are made. However, each year, the corporation must prepare and file T5s for any individuals who received dividends.
If Salary benefits are of no interest to you then paying dividends can be a simple way for business owners to withdraw money from their corporation. Some key advantages include:
Fewer Chances for Payroll Penalties - There are stiff penalties if you are late on remitting payroll deductions because source deductions have to be paid to CRA each month to avoid late payments as well as interest. Paying dividends eliminates the chance of late or missed payroll remittances. That being said, filing of T5s must be completed on-time once per year when paying dividends.
Lower Cost - When paying yourself dividends, there is no need to contribute to CPP, which reduces corporate and personal costs. However, if you want to get more cash at your retirement than salary might be better option because dividends do not allow you to contribute to the Canada Pension Plan.
Easier to Pay with Less Requirements - If you own 100% of your corporation, you can just declare a dividend and transfer cash from the company to your personal account. No need to register for payroll and remit source deductions.
Tax Planning Using Dividends
Dividends can be a useful technique when planning for your personal and business taxes. New businesses can take advantage of an interesting two-year deferral program which allows a business to lend money interest-free to their shareholders for two years and delays tax payments to improve cash flow early on in the business. Other tax planning strategy can allow you to split your dividend income with members of your family through family trusts or shares with discretionary dividends.
There are a lot of moving pieces and things to consider when deciding to pay yourself through salary or dividends. Good news - we love to talk about this stuff, so Contact Us if you have any questions. Our accounting firm has helped many business owners to determine the best strategy to maximize tax savings and improve cash flow resulting in business growth.
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