Paying yourself as a business owner: Salary vs. Dividends

Updated: December 12, 2022

The basics

As a founder and business owner, at some point, you will take compensation from your company to cover your living expenses and maintain your lifestyle. Which option you choose will make a big difference in the impact it makes on your company and your taxable income.

The two most popular options are taking a business salary or dividend payments. What are the pros and cons of both options? In this post, we will go over some of the considerations you should keep in mind when you’re thinking about compensation.

Taking a salary from your business

Taking a salary works the same way as working for an employer. Said differently, you become an employee of your business.

As a founder, if you choose to take a salary as your income source, you will receive an annual salary that will be reduced for standard source deductions for personal income tax, CPP, and EI.

The advantages of taking a salary are as follows:

• Predictable income : A steady and consistent income will make it easier for you to qualify for a mortgage, do your personal taxes, cover childcare expenses, and for your personal budgeting. It will give you a steady cash flow that will let you manage your personal expenses much easier.
• RRSP : A salary allows you to contribute to an RRSP, but dividends do not. This can be a big deal since it can give you a significant tax advantage. Also, if, for any reason, your business goes down and you have to declare bankruptcy, your RRSP funds will be safe from creditors.
• CPP : This has its pros and cons. A salary allows you to make contributions for CPP, while dividends do not. You will benefit from these CPP contributions when you’re older; however, this means you will have less cash today due to the contributions required. If relying on the CPP is a big part of your retirement plan, then a salary will be the option that will help you the most.
• Easy to forecast : If you choose a salary, then it will simply be factored in as another business expense as you will be another one of the salaried employees in your company. Also, your company benefits from the business deduction that comes from paying a salary.

Using dividends to pay yourself

Dividends are paid from the after-tax earnings of the company; therefore, your company will not receive a tax deduction (i.e. taking a salary allows your company to get a deduction). On the other hand,  the tax on dividends are more favourable in the hands of the shareholder.

The advantages of taking a dividend are as follows:

• No deductions : Dividends do not require contributions for CPP. Therefore, both you and your company will save cash today by not having to make CPP contributions. The implication of this is that you will earn less CPP when you’re older. This is something to consider if receiving a pension in retirement is something you are considering.
• Payroll penalties : Source deductions (i.e. income tax, CPP, EI) from salaries have to be remitted to the CRA on a monthly basis. There are stiff penalties for late payments. Paying dividends does not require source deductions and, therefore, eliminates the need for payroll remittances and potential penalties.
• Lower Income Tax Rates : This is probably the main reason why you’ll want to use dividends to pay yourself. There may be a slight tax advantage since you will be eligible to receive a dividend tax credit.
• Taking out a shareholder loan : This is not a way to receive payment in itself since it is technically a loan. But it is a way for you to receive cash from your company that you can use to finance your personal expenses. The main benefit of using shareholder loans is that it doesn’t trigger a tax liability. There are several conditions that need to be met in order to use this mechanism, so make sure you know all the details and understand if it is in the best interest of both yourself and your company.

Which option will let me pay less tax?

The overall tax burden of both options should be determined by calculating the combined tax liability at the (1) corporation and (2) individual level.

As illustrated above, paying a salary or a dividend involves trade-offs between the tax position of your corporation and your own individual tax position.

Furthermore, due to a tax concept called “integration” the tax rules are designed to ensure that the overall tax burden shared by a corporation + the individual are more or less the same in either scenario.

Dividend considerations

It’s important to consider the impact of the qualitative factors outlined above for dividends. Dividends don’t allow you to contribute to CPP or an RRSP. Therefore, if you’re looking to contribute towards a retirement savings vehicle, dividends may not be ideal.

Moreover, if you have investors in your company, declaring dividends becomes tricky. When dividends are declared, they are paid based on the proportionate share ownership for each shareholder. Therefore, a dividend will also have to be paid to your investors based on their proportionate shareholding. It’s a lot simpler to pay yourself a dividend when you’re the sole shareholder of the corporation.

Let us help you Ultimately, the decision on whether you should pay yourself a salary or dividend depends on your personal situation and objectives. We can help you with your decision. Email us: info@verticalcpa.ca

The accounting and tax information provided in this post does not constitute advice and is meant to be for general information purposes only. The information is current as at the date of this post and does not reflect any changes in accounting and/or tax legislation thereafter. Moreover, the information has been prepared without considering your company or personal financial/tax circumstances and/or objectives.