Don’t get confused: salaries vs. dividends

A banking advisor told me a story about his client. The client has been hesitant in making decisions on how to use the funds, which has been piled up in his corporate account. What that means money was sitting as cash. Well, doing nothing is one of the options in how to deal with the funds in the corporation.

Given that new rules on passive income will come to play, it is imperative that business owners think through the situation and make sound decision. Let’s look at the basic stuff . Generally, owners of incorporated business extract funds from the corporation through either salary or dividend.

Why owners like to get paid with salaries then?

1. first of all, the salaries is an expense, which lowers the corporation’s taxable income and ultimately reduce the corporate taxes;
2. salaries help owners to better plan for retirement with the available/predictable resources. What it means that salaries require making contribution to CPP, which is one of the components in retirement plan.Furthermore, basic salary of $5,500 will meet the minimum earning amount to qualify for CPP disability benefits if that has been taken into consideration.
3. Salaries can create more RRSP contribution room. Another way to reduce owners’ personal taxes and plan out the future retirement package.
4. Salaries are required to be eligible for personal income tax credits like child care expense and medical expenses.
5. On financing side, T4s are generally accepted by financial institutions to assess personal financial health. Getting T4 can help qualify for mortgage/ line of credit.

The above is about all pros. What about cons of paying out salaries.

1. Salaries always trigger taxes, in most situations.
2. Issuing T4s is a must before the end of February. T4 summary needs to be sent to the CRA. This is just the annual exercise. Monthly, payroll remittance is a requirement as well.

Can I take dividends instead? Why not?

1. Dividends incur no payroll source deductions. No T4/T4 summary. Yeah!
2. Dividends do not trigger taxes, if it is below certain amount. If corporations can declare $54k eligible dividend to owners, then it is tax-free. Can’t believe it?!

Paying out in dividend also comes with some disadvantages.

1. Dividends are the after-tax dollars. So , there is no such thing – reducing corporate tax by paying dividend.
2. Dividends create no RRSP contribution room as it is considered as passive income instead of earned income.
3. Since no CPP contribution is required, it limits your future retirement income.
4. Dividends are not eligible for personal tax credits like child care expenses.
5. Administrative burden still exists as T5 is required to be issued.
6. A lot of owners don’t take this seriously. First, your articles of incorporation has to allow dividend to be paid out. After the declaration of dividend, corporate minutes should reflect the resolution as well.

Readers may ask, you have been talking about the pros and cons in paying salaries or dividends, then what’s the best solution?

Depends.

If you starts your business at your early age, you don’t have to worry about retirement(well, a lot of planers may disagree), then take the dividend and pay no tax or low tax. One of the key assumptions over here is that the return generated from dividend on your hand should be a lot of bigger than tax saving and benefit derived from paying salaries.

Then, if you run the business and kids are still young, then likely you need to consider taking salaries as you may incur child care expenses so that better utilise the tax credit available to you and your family. As child care expense is deductible one the lower income spouse, please make sure spouse has sufficient income to absorb the tax credit.

You run your business for a long time and feel tired and get ready for retirement. Assuming you have made enough CPP contribution, you can easily take the dividend out as part of purification strategy before selling the business to interested buyers.

One size may not fits all. Some situations may require you to consider hybrid solution of salary and dividend. One thing that you should keep in mind is that the mix of salary and dividend may affect your eligibility of future disability benefit.

So, it is time to come to an conclusion. Decision on salary or dividend depends what you current need and future plans.It is always good idea to chat about your basic requirement with your advisor before the year-end. Should you have any questions in paying yourself in salary or dividend, you can give us a call at 647-872-6656 or drop us a line.