Small business owners operating through corporations may wonder whether paying themselves a salary or dividends will result in a lower tax bill.
Using the proper method to pay yourself from your corporation can affect more than just your income tax liability.
Dividends may create the lowest personal tax bill, but they do not create RRSP contribution space, build up CPP, or allow you to claim childcare credits.
What you get from government programs, credits, and loans depends on the form of your compensation.
This post will examine salary vs dividends in detail to ensure you choose the right compensation strategy to build wealth.
Why do I pay myself a salary?
Paying yourself a salary requires opening a payroll account with the Canada Revenue Agency. The CRA will require you to withhold and remit income taxes each time you pay yourself.
Additionally, you must pay the CPP on your income.
If you own a small business and your net income exceeds $3,500, you will pay twice as much CPP as an employee since you are paying both the employer and employee portions.
Having said that, the employer’s portion of the CPP is tax deductible.
Paying yourself a salary is a great option if you rely on CPP as part of your retirement savings. Your RRSP contribution room can also be built using your business salary.
Why do I pay myself dividends?
Your corporation can pay dividends to its shareholders. Investment income is treated differently than business income when it comes to dividends.
Dividends might have a lower personal tax rate than salaries since you can claim a dividend tax credit to reduce your overall tax burden.
Dividends are prepared for shareholders by moving cash from your corporate account to their accounts. Dividends received must be reported to the CRA via a T5.
There will be no payroll (salary) payments, so source deductions do not need to be submitted. When you do not want to pay CPP contributions, paying yourself dividends might be a good option.
Dividends also do not contribute to RRSPs, so it is recommended that you have a retirement plan in place.
So, how do I pay myself?
Business owners/managers can pay themselves a salary, dividends, or a combination. Using the proper method to pay yourself from your corporation can affect more than just your income tax liability.
Dividends will likely create the lowest personal tax liability, but they won’t allow you to contribute to your RRSP, accrue CPP, claim WCB, or claim childcare credits.
Government programs and credits and lending institutions’ ability to give you loans can be affected by the type of compensation you receive.
However, your business situation will determine how you should proceed. You won’t have to pay into CPP if you choose dividends, so you’ll have fewer costs.
However, by issuing yourself dividends, you won’t be able to create contribution room in your RRSP, so be careful when contributing to your retirement savings.
When applying for a mortgage or other non-business credit, dividends are not accepted as salary.
Several other factors can influence whether you should pay yourself a salary or dividends, such as other sources of income. Consult a certified tax specialist to determine the best option for you.