Salary vs Dividends
One of the common conversations we have with our clients is the topic of, “How do you compensate yourself?” It’s a question we field from every kind of client, but it’s particularly familiar coming from those just starting out and setting up their corporations for the first time.
And the answer seems straight forward. You pay yourself by way of either a salary or dividends.
But deciding on the best option for your unique situation can be a little more complex. So let’s have a look today at both options, with information to help you make the best choice.
Salaries are a deduction to the corporation. For example, if the corporation has $100 worth of income and the owner draws $100 worth of salary, then the corporation is going to have zero taxable income.
Meanwhile, a dividend is considered to be an after-tax distribution. In this case, if a corporation has $100 worth of income, it pays tax on that $100 and whatever is left over is paid as a dividend to the shareholder. So there are two levels of tax here: one paid by the corporation and a second paid by the individual receiving the dividend.
At a glance, with two tiers of taxation, this would seem to be a less favourable option. But that’s not necessarily the case. The laws take into account that the dividend has been taxed once already, so the personal tax that you pay on receiving the dividend can be considerably lower than you’d pay after receiving a salary.
The bottom line is, because of that reduced rate on dividends, both options generally leave you – tax-wise – in pretty much the same position.
But there are some other significant differences that will help you make your decision.
When Salary is the Best Option
Depending on your age, paying yourself a salary may prove beneficial in helping you build up your Canada Pension Plan entitlement upon retirement.
Additionally, if contributing to an RRSP or deducting child card expenses are important considerations for you, then paying yourself a salary may, again, be your best path. Salary is considered to be earned income, which entitles you to more room for RRSP contributions and the ability to deduct child care costs.
Those benefits aren’t available to you when you pay yourself in dividends.
When Dividends are the Best Option
The biggest advantage to dividends is simplicity. Essentially, if you own the company and need money, you can just write yourself a cheque whenever you wish.
And if you’re not really concerned with child care deductions, RRSP room or CPP contributions, then dividends may save you some money through avoidance of CPP costs.
So, those are the bigger considerations when making your decision on how to pay yourself. The best news of all is, whatever you decide, you’re not locked in for life. If you choose a salary this year, you have the option to switch to dividends for next year.
You can even split the difference and combine the two, if that’s what make sense for you.
To hear more on this subject, we invite you to listen to Episode 8 of the Vaive and Associates Podcast.