Entrepreneurship 101: Salary Or Dividend Pay?
This is a guest post from True North Accounting, a trusted partner of Goodlawyer. With knowledgeable CPAs and bookkeepers in Calgary and Okotoks, True North helps make life easier for small business owners with bookkeeping, accounting and tax advice. Their streamlined process and clear, all-in pricing helps business owners save time and money.
As a small business owner, you may wonder if you should pay yourself a salary or dividends? Which is easier? Which means lower taxes? This is one of the most important financial and tax decisions you may make, so let us help you decide which is best for your situation and goals.
Who Is This Advice For?
- Owner-managers of incorporated small businesses operating in Alberta
- Shareholders and their spouses who are active in their small businesses
- Service-based industries including contractors, consultants, marketing freelancers, IT and software developers, professionals, tradespeople and realtors
General Concepts:
As a business owner, you need to be familiar with the rules around personal expenses and business expenses. If the business pays for your personal expense, this payment should be included in your taxable income.
- When the corporation earns profits, the cash belongs to the corporation, not the owners. They cannot use those profits for personal spending without first declaring the payment as income.
- The corporation cannot lend money to the owners without tax consequences. If the owners have drawn cash, borrowed money, or used the corporate bank account for personal expenses during the year, that money needs to be repaid, or taken as a wage or dividend prior to year-end.
- There are two general ways for owners to get paid. You can pay yourself dividends or wages (also known as salary, bonus or payroll).
Paying Yourself In Dividends
When you pay yourself in dividends, you get paid as a shareholder (or an owner) of the corporation. The corporation issues T5 slips to the owners showing the amount of dividends paid. The figures from the T5 are then used to calculate tax owing on your personal tax return.
- Dividends are not a tax deduction. They are a distribution of profits (usually), which means the corporation likely has taxable income.
- The corporation will pay some of the tax, and the owners will personally pay some of the tax. Owners should expect to owe tax personally.
- Dividends are taxed lower than wages at the personal level to reflect that the corporation has already paid a portion of the taxes. When comparing taxes owing between wages and dividends, be sure to include the corporate tax as well.
- No Canada Pension Plan (CPP) or Employment Insurance (EI) is payable on dividends.
- Dividends do not create RRSP contribution room. Only earned income creates RRSP contribution room.
Paying Yourself In Wages
When you pay yourself in wages, you get paid as an employee of your own business by being put on payroll, or declaring a one-off bonus. The corporation issues a T4 slip showing the amount of wages. These must be filed by February 28.
- Wages are a tax deduction to the business, meaning the business will not be taxed on the amount of the wage.
- Wages are taxed personally at the applicable personal tax brackets. Learn about combined federal and Alberta tax brackets.
- For CPP, 10.5% must be paid on wages between $3,500 and $58,700. Half is paid by the employee and half is paid by the employer. Wages over $58,700 per year are exempt from CPP, so the maximum owing in a year is $5,796, or $2,898 each for the employee and employer.
- Owners are exempt from paying EI premiums.
- Wages are “earned income," which increases your RRSP contribution limit. RRSP contributions can be used to reduce your tax.
Get on payroll and have the company pay the income tax and CPP for you. Monthly payroll remittances are due 15 days after the month when the owner got paid.
Which Option Has Lower Taxes?
Generally, total taxes on wages are lower than dividends, but wages tend to be more expensive because of the CPP.
To recap, dividends seem easier, but you still need to save a percentage of each dividend draw for your personal taxes and make corporate and personal income tax instalments. You may end up paying more tax than salary, and you must be more active in your retirement planning.
When you pay yourself a salary, you invest for retirement by paying into CPP and contributing to RRSPs. You are eligible for CPP and EI benefits, Canada Workers Benefit and COVID-19 relief. You also get your business to pay your taxes, so you owe nothing or get a refund come tax time.
Take Advantage Of Tax Deferral
The bulk of tax is paid at the personal level, meaning the real tax benefit to incorporating lies in the ability to defer the personal portion of the tax bill each year. To a certain extent, the owner has the ability to decide how much tax to pay in any given year.
We recommend that you determine your basic living costs, and base your compensation on that. If there is excess cash or profit in the corporation after the owners have been paid, the extra cash can be kept in the corporation. Only corporate tax rates (11%) would apply on that excess.
Other Ways To Be Compensated
There are a few one-off ways for owners to take cash from the corporation. These include:
- Shareholder loans: This is only if the owner has lent the company money. The repayment is not income and is tax-free.
- Management fees: If the owner of the corporation is another corporation that provides services, then management fees may be an option.
- Other tax account balances: Capital Dividend Account or Paid Up Capital (PUC)
Let Us Run The Numbers For You
Our Chartered Professional Accountants (CPAs) can talk you through the pros and cons of salary or wages vs dividends, and calculate your after-tax income under various scenarios to help you determine what’s best for your specific situation. January and February is when we calculate the exact amount of tax owing under dividends, and the exact amount of tax and CPP under wages for our clients. We can also give you the optimal balance of dividends vs salary.
We have extensive knowledge of the changing tax laws, including ones related to self-employed professionals like yourself. We provide bookkeeping and tax services to small business owners in Okotoks and Calgary, including everything from deductions, write-offs, expenses, tax returns, GST filing and more. If you still have questions about whether wages or dividends are right for you, book an appointment with us.
