Blog Posts

Salary vs. Dividends

November 30, 2020

The basics

As a founder, at some point, you will take compensation from your company to cover your living expenses and maintain your lifestyle. Should you take a salary or a dividend? 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.

Salary

Taking a salary works the same way as working for an employer. As a founder, if you choose to take a salary, you will receive an annual salary which will be reduced for standard source deductions for personal income tax, CPP, and EI.

The advantages of taking a salary are as follows:

  1. Predictable income: A steady and consistent income will make it easier for you to qualify for a mortgage and for budgeting
  2. RRSP: A salary allows you to contribute to an RRSP but dividends do not
  • 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 contributions required

Dividend

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, dividends are more favourably taxed 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 from not having to make CPP contributions. The implication of this is that you will earn less CPP when you’re older.
  • 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 do not require source deductions and therefore, eliminate the need for payroll remittances and potential penaties.

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.

Corporation Individual
Salary Lower Tax Burden due to salary deduction Higher Tax Burden
Dividend Higher Tax Burden due to no salary deduction Lower Tax Burden

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.

2 thoughts on “Salary vs. Dividends

  1. Anjana G. says:

    Thank you for breaking down the tax implications of both options – the pros and cons are so clearly laid out! Appreciate the share!

    1. aliladha says:

      Glad you like it! Thank you.

Leave a Reply

Your email address will not be published. Required fields are marked *