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Salary or Dividends: How Do I Pay Myself?

Updated on November 11, 2012

In this article I will explain some points then you will get a picture of what is important to you. It is understood beforehand that the business is incorporated and is eligible to be qualified as "CCPC ( Canadian Controlled Private Corporation)" .

The correct answer is entirely dependent on the business owners’ financial situation. It’s best to get a consultation from professional financial planner, accountant and tax lawyer.

- What is his income level?

- What are his cash flow needs?

- What is the corporation annual income?

- Is RRSP and other personal income tax deductions is important to him?

- How old is he/she?


You can do three things.

1. Pay yourself by Salary.

2. Pay yourself by Dividends.

3. Pay yourself by combination of both Salary / Dividends.


Comparison between Salaries and Dividends

Salary
Dividends
• Salary is considered to be active income, also known as Earned Income
• Dividends are considered to be passive income, also known as Investment Income.
• Salary is tax-deductible to the company, Salary is taxable as an Employment’s Income and it is added to the owner’s income. It is taxed at marginal tax rates, according to your province.
• Dividends are profit to its company’s shareholder and are not tax deductible to company. They are paid after tax deductions. Furthermore, The Canada Revenue Agency (CRA) gives dividend tax credit , as a result it reduces income taxes on dividends.
• For Salaries: You have to file and pay your deductions on a monthly or a quarterly basis. Late payments will result in interest and fines. If you reside in Quebec you have to file T4s and RL-1s with the required summaries. You also need to setup a payroll account with Canada Revenue Agency, if you will pay yourself a salary.
For Dividends: • Dividends require you to file T5s and its related summaries yearly
• To be eligible for Canadian Pension Plan Benefits (CPP), you have to pay yourself salary so CPP Premiums (Tax) are deducted monthly to contribute into your retirement income. However you will receive these benefits once you turned 60 years old.
• By paying yourself only dividend income you may not contribute enough towards your retirement income.
• Your RRSP (Registered Retirement Savings Plan) contribution is deducted 18% on your “Earned Income” a maximum of $22,450. *Rates might have been changed.
• When you pay yourself dividends, you do not contribute to RRSP to reduce your taxes payable.
• Childcare Expenses are deducted on “Earned Income”
• By not paying to CPP / RRSP , you can save money, make sure to discuss this with your tax lawyer to adjust accordingly when considering tax liabilities vs salaries

Tax Rate:

The tax rate for Federal and Ontario combined for CCPC (Canadian Controlled Private Corporations) is

- On $200,000 of Business Income, Tax rate is 20%

- On $200,000 to $300,000, Tax rate is 36.5%

- On $300,000+, Tax Rate is 42-43%

(The rates might have been updated , in some areas Business under $500,000 are considered to be Small Business)

The Best way to avoid getting taxed at higher tax rate is to give yourself enough salary/bonus to reduce the company’s business taxable income however if the salary paid is not reasonable it will be rejected, for dividends there is no issue.

For example if the business owner reduce the company’s business taxable income to $200,000 or $500,000 in some cases then it’s obvious that, this business falls into 20% Tax Bracket. After the company has paid all its taxes then the company can pay the dividends out. This integration balances the tax.

It is important that this decision is taken by keeping into consideration

- Owners’ Income Level

- Company’s Income Level

- Cash Flow Needs.



John Wilson, owner of ABC Accountants, makes $500,000 after expenses, but before tax, in his incorporated practice. He is married to Mary who earns income only from the business. In the first scenario, Mary receives a salary of $40,000 per year and
John Wilson, owner of ABC Accountants, makes $500,000 after expenses, but before tax, in his incorporated practice. He is married to Mary who earns income only from the business. In the first scenario, Mary receives a salary of $40,000 per year and | Source
In the second scenario, John and Mary each receive $120,000 in dividends; savings are left in the company. As a result, total taxes are lower and savings higher.
In the second scenario, John and Mary each receive $120,000 in dividends; savings are left in the company. As a result, total taxes are lower and savings higher. | Source

Conclusion:

Now the correct answer to pay yourself salary or dividends, entirely depends upon the business owner’s financial condition, It is therefore necessary to take advice of an expert accountant, tax lawyer or financial planner. The basic idea is that to withdraw certain amount of cash for you needs while keeping some in the corporation. You need to balance both, so you don’t pay yourself more or less to be disregarded for salary and don’t keep too much money into corporation which can impact higher tax liabilities. You may not be disciplined enough to save for your retirement, and this method of forced paying RRSP/CCP contributions can help in the future or either take a plan outside of your corporation and save money by paying yourself dividend income.

Tax Principles, 2012 - 2013 Edition, Volume I & II with Companion Website

Byrd &Chen's Canadian Tax Principles, 2012 - 2013 Edition, Volume I &II with Companion Website
Byrd &Chen's Canadian Tax Principles, 2012 - 2013 Edition, Volume I &II with Companion Website

Tax Principles, 2012 - 2013 Edition, Volume I & II with Companion Website

 

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