When it comes to owning your own business, there are plenty of financial elements to wrap your head around. Between balancing budgets and paying taxes, there may be little time left to learn about much else. But one of the most important things to understand about your small business finances is the different ways in which you can pay yourself. After all, your business is your livelihood, and you need to earn money to cover the expenses of life!
If your business is set up as a corporation in Canada, you have the option to receive payment as a business salary, dividends, or a mix of both. Below we will go over the differences between each type of payment as well as how you can choose the best option for you and your business.
Let’s start with salary or wages. When you pay yourself a salary or wage, this amount becomes an expense of your corporation as well as employment for you personally. This means that you will receive a T4, and the expense will reduce the corporation’s taxable income and corporate taxes owing.
If you would like to pay yourself a salary, your corporation needs to have a registered payroll account with the CRA. Once you have that setup, your corporation will be able to start paying you. With every paycheck, the corporation will withhold CPP and income tax deductions. These source deductions will then be remitted to the Receiver General at the CRA on a regular basis, and your corporation must prepare and file a T4 for all employees on their payroll each year. In this case, even though you may own the company, you are treated as a separate individual employee and paid as such.
Some benefits of choosing to pay yourself a salary are:
- Steady and predictable income: Having a regular, predictable income makes planning your personal budget much easier than if your income fluctuates throughout the year.
- CPP Contributions: While a salary will allow you to contribute to the Canada Pension Plan (CPP) via the regular deductions on your paycheck, paying yourself with dividends does not. This does mean that you and the corporation are spending more money now, but you will also end up with more money later on.
- Mortgage application benefits: One of the top things that mortgage lenders look for in a mortgage application is a steady source of income. If you have a consistent salary rather than inconsistent dividend payments, you may be more likely to qualify for a higher mortgage.
- Room to contribute to RRSP: Unlike with dividends, paying yourself via salary or wage allows you to build RRSP contribution room and save more for the future.
- More predictable tax bill: Because your income tax will be deducted from each paycheck and remitted to the Receiver General, you will not pay income tax when you file your personal tax return. This means that you can avoid a surprise tax bill when tax season rolls around in April!
Unlike a salary, dividends are payments that are made to a corporation’s shareholders, taken from the after-tax earnings of the corporation. Since they are taken after-tax, they do not count as a corporate expense and do not reduce the amount of corporate taxes to be paid.
To pay yourself in dividends, the process is pretty straightforward. Dividends have to first be declared, and then the cash will be transferred from the corporate account to the shareholder’s (your) personal account. Much like with the process for T4s, the corporation must prepare and file T5s for any shareholders who were paid via dividends during the tax year. Dividend payments can become complicated if you have a large number of shareholders and different share classes, but it remains simple if you are the only shareholder.
Some benefits of paying yourself with dividends are:
- A simple way to withdraw money from the corporation: Paying dividends is an easy way to pay yourself directly from the corporation – and the process is even easier if you own 100% of your corporation. Just declare your dividend and transfer money straight into your personal account!
- Lower cost upfront: Because you do not need to contribute to CPP with dividends, the upfront personal and corporate costs are reduced. While this means more cash in your pocket now, the downside is that you are saving less for retirement later.
- Reduced chance of payroll penalties: If you have a payroll account and are paying salaries or wages, you must pay your remittances on time or risk expensive penalty charges. Dividend payments remove the monthly chance of a late or missed payroll remittance. Just remember that you will still need to file those T5s on time once per year!
So, the question you probably have now is ‘which option will allow me to pay less tax?’. While this is a great question, the answer is, unfortunately ‘it depends’. Due to integration, there is little to no difference in overall income tax paid (corporate and personal) if you compare the same payments in salary and dividends. This is because salary will reduce your corporate tax and increase your personal tax, while dividends will reduce your personal tax but won’t affect your corporate tax. That being said, there may still be some savings to be had. Be sure to do some calculations with your accountant to determine which option will be the most financially viable.
Finally, besides the tax amounts, there are other reasons why you may choose either a salary payment or a dividend payment:
- If you are often forgetful when it comes to administrative tasks (like source deductions), you may be safer to choose dividend payments.
- If you are considering having children and/or taking parental leave, you might want to consider salary or wages as deducting and remitting employment insurance amounts can allow you to collect maternity or parental benefits.
- If you have low personal or household income for the year, you may want to consider taking a small salary to trigger the working income tax benefit. This is a refundable tax credit that provides tax relief for eligible low-income households.
- If you are looking to purchase a home and want to qualify for financing, it is likely better to choose the salary option. This will assure your mortgage lender that you have a steady income and are a solid lender.
No matter how large or small your business is, there is definitely a lot to consider when deciding to pay yourself via salary, dividends, or both. If you need help deciding which option is best for you, a second opinion from the professional Victoria accountants team can help turn a difficult decision into a no-brainer.