Should You Pay Yourself a Salary or Dividend? 7 Considerations For Small Business Owners

While incorporation has many benefits for small business owners, it does introduce additional complexities that are not faced by registered  businesses.  Unincorporated business owners are essentially taxed on their net business income, which allows for more time to devote to tax planning and how to spend all of your richly deserved profits.   Incorporated business owners, on the other hand,  cannot just withdraw cash from their businesses as the need or whim arises.  There needs to be a formalized structure in place which usually takes the form of either salary or dividends.  When deciding whether to take salary or dividends there are several factors to consider:

---

---

Related: How to Pay Shareholder Dividends & What is a Capital Dividend

1. Salaries are considered to be active income since they are paid to employees, while dividends are passive income which are paid to shareholders. Since RRSP contribution room is calculated on active (earned) income, if your only source of income is dividends you will not be able to build RRSP contribution room, nor benefit from the tax benefits. Similarly child care expense deductions are based on earned income .

2. Salaries are paid from pre tax income which means that. they are tax deductible. Dividends, however, are paid from after tax earnings and are not tax deductible. To compensate for the additional taxes paid on a corporate level, the CRA and MRQ require a gross up of dividends which is then reduced by a dividend tax credit, thereby resulting in a lower income taxes on dividends. The revenue agencies are interested in “integration” whereby the taxes paid on salaries or dividends are approximately the same, however, since it is impossible to achieve perfect integration this is not always the case. Note that dividends for small businesses who pay tax at the small business tax rate are referred to as ineligible dividends.

3. Salaries require additional administration in that you have to calculate, file and pay your deductions at source on a monthly or quarterly basis. Late payments result in penalties and interest. At the end of the year you have to file T4s (and RL-1s if you live in Quebec) along with related summaries. Dividend payments only require annual preparation of T5s and summaries. No payment is due at the time of filing the T5 (although quarterly instalments might be required based on previous years income)

4. Salaries, within reasonable limits, can be used to reduce taxable business income to the small business limit which enjoys a significantly lower tax rate. Care must be taken that the salaries paid are reasonable or might be disallowed. Since dividends are paid from after tax income, they have no impact on profit. It should be noted that to be considered a small business in Quebec, you must have employees working over 5,000 hours per year. Otherwise the Quebec small business tax deduction is not available .

5. CPP and QPP contributions are not payable on dividends. This can result in a maximum savings of almost $10,000, which should be taken into consideration when calculating tax liability versus salaries. The downside is that you will not be entitled to CPP/QPP benefits upon retirement. For 2019, the maximum monthly amount you could receive as a new recipient starting the pension at age 65 is $1,154.58. The average monthly amount is $679.16. Your monthly amount will depend on how much you have contributed to the plan.

   You can get an estimate of your monthly CPP retirement pension payments by logging into your My Service Canada Account

   You can get an estimate of your monthly QPP retirement pension payments by logging into your Retraite Quebec account using your login and password for my account for individuals (there is generally a single login to all Revenue Quebec and Service Quebec portals)

6. When calculating the SRED tax credit, eligible salaries are a significant part of the calculation, whereas dividends do not qualify for the credit. If the business owner contributes to the SRED project being claimed, it may make more sense to draw a salary to ensure a higher reimbursement.

7. Salaries must be paid to employees of the company, while dividends must be paid to shareholders. If you are one but not the other, then the choice is clear.

8. It should be noted that shareholders, who own at least 40% of their corporations, whether they receive dividends or salaries are not entitled to Employment Insurance (EI) and by the same token are not required to pay EI (if they take salaries) unless they specifically sign up for the self employment employment insurance program.
   

This Salary vs Dividend Scenario provides some insight into the tax implications of taking a specified salary versus a dividend.

You can also estimate your tax liability using the Simple tax calculator. When including dividends, the ineligible dividends field would be used.

The choice of salary vs dividend depends on the specific circumstances of the business owner.  It may be more beneficial to take out only the funds necessary to maintain your lifestyle while retaining any excess cash in your corporation, thereby deferring taxes.  Alternatively, by taking out a salary you may be able to maximize your RRSP and CPP contributions which can reduce your tax liability.  As always with these situations it is good to solicit the advice of your accountant.  

Ronika Khanna is an accounting and finance professional who helps small businesses achieve their financial goals. She is the author of several books for small businesses and also provides financial consulting services.

Subscribe to our biweekly newsletter to receive articles, tips, tools and special offers for small businesses.