Salary vs. dividends: which is the better option for you?

The following is a guest post by Stacy B. Miller


So you’ve set up a small business and with God’s grace, it’s running smoothly. Your company pays a fixed wage to employees. But what about you?

This company is your brainchild. You’re working hard every day to help your company meet the pinnacle of success. You have a family to look after and for that you need money. Now here comes the main question: how do you want to pay yourself? Salary or dividends?

You can pay yourself by salary. You can pay yourself by dividends. The choice is yours. You can even pay yourself a mix of both. Both have pros and cons. Here’s a brief comparison between the two.

When you pay yourself a salary

The best part of paying yourself a salary is that you have a personal income. You can contribute to an RRSP. You can easily do income splitting by paying a wage to your children or spouse. The corporation will be eligible for a tax deduction for the salary or bonus paid out.

You’ll may pay into the Canada Pension Plan (CPP). This is your retirement pension plan. Remember, your CPP will depend on the amount you have contributed and the number of years you have contributed.

The biggest drawback of a salary is that it is taxable. Unlike dividends, the wage is 100% taxable. This may increase your tax load.

There is yet another disadvantage of paying yourself a wage. You have to create a payroll account and do the necessary paperwork. The process is complex and involves a lot of steps.

What is the profit margin of your company? Does it vary from year to year? If so, then there can be tax problems if you pay yourself a wage. This is because you can’t carry back a business loss in the next few years.

When you pay yourself dividends

The biggest benefit of paying yourself dividends is that you have to pay less personal tax. This is because dividends are taxed at a lower rate. You can save money since it isn’t required to pay into the Canadian Pension Plan. Moreover, the process of paying yourself dividends is very simple. First, you have to issue a check in your name from your company at the end of the year. Next, you can update your company’s minute book and make a director’s resolution for the dividends paid.

The biggest disadvantage of paying yourself dividends is that you can’t contribute to an RRSP since you don’t have any income. Moreover, you may not qualify for other personal income tax deductions like child care expense deductions.

Conclusion

Usually, salary is paid so that the corporation does not earn above $500,000, and then the dividend is given out if more income is needed. This is due to the fact that $500,000 is the small business limit. The Canadian Corporation (CCPC) pays income tax at a lower rate up to this amount of income. You can check the summary of income tax advantages to get more details.

Ultimately, everything depends on your financial circumstance. You need to decide if you wish to pay yourself salary or dividend. Rather, you have to analyze your financial scenario and then make a decision. Think about your cash flow needs. Figure out your income level and the company’s expected revenue of the year. Ask yourself what is more important – RRSP or personal income tax deductions. Look at your age.

If you have no intention to contribute to RRSP, CPP and don’t need to cover childcare expenses, then it’s better to opt for the dividend strategy. Moreover, family members (mainly shareholders) who don’t work in your company or don’t offer any service in any capacity, must get dividends provided they have no other source of income.

If you’re still confused, then it’s best to get professional advice from an accountant or a tax attorney or a financial planner. Analyze the pros and cons of salary and dividends carefully since your decision will have a direct impact on your financial life.

Author Bio – Stacy B. Miller is the content editor at Oak View Law Group. Her articles revolve around topics related to debt, credit, laws, money, personal finance, etc.

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