When it comes to taking money out of the business, the most common question asked by a business owner is – what’s the best option? Is it salary? Or is it dividend? What’s the difference between salary vs dividend?
The answer is not a straightforward one because there are many factors that may impact your decision. Let’s compare the benefits of each option.
Benefits of Paying Salary
Paying yourself a salary means you are putting yourself on the company’s payroll. You will first need to register a payroll account with the Canada Revenue Agency (CRA). Each time when you get paid, the company will need to withhold payroll deductions from the paycheque such as the Canada Pension Plan (CPP) and income taxes. These payroll deductions are then remitted to the CRA, typically on a monthly basis. Some of the key advantages of paying yourself a salary include:
Retirement Benefits
Paying yourself a salary allows you to accumulate RRSP contribution room, whereas paying yourself a dividend does not. RRSP is an effective tax vehicle to deduct taxes in the year of contribution and to defer taxes on all accrued earnings until withdrawal.
Similarly, paying yourself a salary requires you to make contributions to CPP. This means you will benefit in the future when you collect CPP. Dividend is not eligible for these retirement benefits because it is considered an investment income and not an “earned income”.
Personal Tax Credits and Deductions
You will be eligible for employment credit by paying yourself a salary. It is an additional tax credit that can be used to offset against taxes on your personal tax return.
If you want to claim child care expenses, you must have accumulated sufficient earned income to make this happen. Similar to the RRSP discussion above, salary is a source of earned income whereas a dividend is not. If you don’t have any earned income, then you are not eligible for child care expense deduction.
Personal Tax Bill and Tax Instalment
Since you have already paid income taxes to the CRA through regular payroll deductions, your personal tax bill should be minimal (if any at all) when you file your taxes. Conversely, dividend is not subject to payroll deductions and you will likely end up with a much higher tax bill depending on the amount of dividend paid during the year. If your personal tax bill is greater than $3,000, you’ll need to remit tax instalments on a quarterly basis, otherwise you’ll be charged with instalment interest.
Personal Loan Qualification
If you apply for a personal loan such as a mortgage, lenders prefer to see steady and predictable income prior to approving the loan application. Earning salary income will help show that steady income because you are paid on a set schedule, whereas dividend income may not be looked at as favourably.
Benefits of Paying Dividend
Dividends are payments to shareholders of a corporation with after-tax dollars. In practice, paying dividend is straightforward. Dividends are declared and cash is transferred from the business account to a shareholder’s personal account. Some of the key advantages of paying yourself a dividend include:
Lower Costs
Dividend is considered an investment income, which is a return on your shares. As such, they are not subject to normal payroll deductions and charges such as CPP, income taxes, provincial health taxes, and workers’ compensation premiums.
Simplicity
If you own 100% of your company, you can simply declare a dividend and transfer cash from the company to your personal account. There is no need to register for payroll and remit payroll deductions.
Minimize Payroll Penalties
Sometimes, complying with payroll remittance obligations on a regular basis can be an administrative nightmare. If you are late in remitting payroll deductions or made a calculation error, the penalties could be hefty. Paying yourself a dividend reduces the chance of being charged with these penalties.
Income Splitting
Dividends can be an effective means of income splitting with family members who may own shares in the business directly, or indirectly through a family trust. They are not subject to the same reasonability test as salaries are, which limits the amount you can pay family members to an amount similar to what you would pay someone else for performing the same duties.
So What’s The Best Option?
It depends on your situation.
If you are a one-person company and you find it difficult to keep up with payroll remittance duties, then it may be easier and less costly to pay yourself a dividend.
If you plan on buying a home in the near future and need to qualify for a mortgage, it may be better to pay yourself a salary. Lenders like to see the steady and predictable income more than sporadic dividend payments.
If you plan on having children in the near future and would like to receive maternity or parental benefits, then it may be better to pay yourself a salary. This is because remitting Employment Insurance premiums enables you to collect these benefits.
If you already have payroll set up for the company, then you may wish to consider a combination of both salary and dividend to enjoy the benefit of both payment methods.
As you can see, salary vs dividend is not an easy decision to make. You need to consider the pros and cons of each option in the context of your personal and corporate tax circumstances to arrive at the right decision.