If you have set up your small business as a corporation in Canada, you have a choice as to the form of compensation you wish to receive. You can pay yourself a business salary, receive payment in dividends, or use a mix of both. However, there are advantages and disadvantages to receiving a salary versus dividends for business owners. It is, therefore, important to determine the type of compensation that best accommodates your financial situation.
Pros and Cons of Receiving a Business Salary
If the corporation pays you a business salary, the main advantage is that you have a personal income. This means that:
- You will be paying into the Canada Pension Plan (CPP) in Canada. What you will ultimately receive in retirement benefits from CPP is based on how much, and for how long, you contributed, so this can be an important retirement consideration.
- The business salary or bonus paid out will be a tax deduction for the corporation.
- Besides paying yourself, you can do some income-splitting by paying salary to related employees such as a spouse or children.
- You can take advantage of other investment vehicles for retirement by contributing to a Registered Retirement Savings Plan (RRSP) or a Tax-Free Savings Account (TFSA).
A salary gives you a personal income.
A salary allows you to contribute to a retirement account.
A salary or bonus is a tax deduction for your corporation.
You must set up a payroll account and prepare all of the paperwork.
Investing in a retirement account means that you pay twice as both the employer and the employee.
A salary is 100% taxed, which could increase your tax burden.
Drawbacks to receiving a salary from your corporation include:
- Your personal income is 100% taxable, which could increase your tax load.
- As for the Canada Pension Plan (CPP), you must pay both portions of CPP, as you will be both the employer and the employee.
- You will have to set up a payroll account with the Canada Revenue Agency and prepare and file all of the related paperwork.
Pros and Cons of Receiving Dividends
If the corporation pays you dividends, the advantages are:
- Dividends are taxed at a lower rate than salary, which can result in paying less personal tax.
- Dividends can be declared at any time, allowing you to optimize your tax situation.
- Not having to pay into the CPP can save you money.
- Paying yourself with dividends is comparatively simple. You write a check to yourself from your corporation and at the end of the year, you update your corporation's minute book and prepare a director's resolution for the dividends paid.
There also are disadvantages to receiving dividends, such as:
- You may want to pay CPP regardless of how you receive profits, as not paying can lessen the amount of CPP you are entitled to receive when you retire.
- Receiving dividends doesn't allow you to contribute to an RRSP, as you don't have any income.
- Receiving dividends instead of a salary prevents you from claiming other personal income tax deductions, such as childcare costs.
Dividends are taxed at a lower rate than salary.
There's a simple process for paying yourself that doesn't require a payroll.
Dividends can be declared at any time.
You will not have income for investments such as a retirement account or other financial account.
You will not be able to claim other personal income tax deductions for expenses.
Choosing to Receive Both Salary and Dividends
Often, a business salary and bonus are paid out to ensure a corporation doesn't earn over $500,000, which is the small business limit in Canada. Up to this amount, a Canadian-controlled private corporation (CCPC) pays income tax at a much lower rate than it would on income over this amount—at a tax rate of about 16%, depending on the province from which it operates.
While it's important to be able to pay out a salary so income does not exceed the $500,000 limit, the decision to receive pay in salary or dividends is completely dependent on a business owner's personal financial circumstances. Considerations include:
- Income level
- Cash flow needs
- Projected annual earnings
- Importance of personal cash for investments and tax deductions
- Your age
This decision is best made with professional advice from an accountant, a financial planner, or a tax lawyer.
Sole Proprietorship or Partnership
As a business owner, how you wish to pay yourself is a personal decision that should be made based on your financial situation, as well as those items that will benefit you the most. You may decide that personal income is most important or dividends, or a mix of both. Engage a financial professional to help you determine a form of compensation that works best for you and your business.