Decisions, decisions, decisions. If you own an incorporated company, the amount of decisions you have to make can seem staggering at times. And one of the most important decisions you have to make affects both you and your company: whether to pay yourself in dividends, in wages, or in a combination of both.
The better you understand the pros and cons of both dividends and salaries for your incorporated company, the better you’ll be able to make this decision confidently. Let’s jump in.
Salaries: What Business Owners Need To Know
Most people know what a salary is, namely a fixed amount of money paid to an employee in regular intervals. It’s usually paid monthly, it usually includes certain benefits, and taxes are withheld automatically.
So should you pay yourself a salary? Maybe. First, be sure you understand the pros and cons.
- Assuming you are based in Canada, receiving a salary means you will be contributing to the Canada Pension Plan (CPP), which gives you a pension in retirement. These will be deducted from your salary automatically, which usually also leads to less surprises come personal tax time.
- Salaries also let you contribute to a Registered Retirement Savings Plan (RRSP), further preparing you for retirement.
- Salaries are steady and predictable, and can therefore provide a useful financial record when applying for loans, mortgages or government assistance.
- Finally, depending on income, salaries could reduce your corporate income tax.
- Salaries require you to set up a payroll account with Canada Revenue Agency, leading to lots of complicated paperwork – unless you’re set up with an easy to use cloud-based payroll system, of course!.
- Yes, you contribute to your personal CPP, but you also have to pay the employer portion of CPP as well.
- You pay tax on 100% of your salary, which might increase your personal tax load.
Dividends: What Business Owners Need To Know
Dividends are payments given to shareholders, drawn from after tax earnings.
Is a dividend right for your company? Again, you need to understand the complete context to make this decision.
- Maybe you don’t want to contribute to (or plan to receive) CPP and EI. Dividends don’t require these government deductions, leaving you more cash in hand at the end of the day.
- Dividends don’t require a payroll and are often much simpler to pay, requiring less assistance from an accountant (or none at all).
- Dividends have a lower tax rate than salaries, and you can declare them at any time, which can lead to less personal tax.
- The first ‘pro’ of dividends listed above will be a con for many people, who, for many different reasons, may want to contribute to CPP and EI.
- RRSP contribution room is based on earned income only, which does not include dividend income, again making planning for retirement more difficult if you receive dividends only.
- You cannot claim personal income tax deductions like childcare costs from dividend income.
How to Choose
So how do you choose the payment method that is right for your business? The answer, as you might have guessed, isn’t black and white. The reality is that these are complex issues, and complex issues can require years of study to fully understand – more than can possibly be covered in a single blog post. Issues like your number of shareholders, your existing payroll structure, and your long term plans all come into play.
Further complicating the matter, sometimes the best option is actually a combination of both salary and dividends. This can allow you to maximize the benefits of both while minimizing your tax burden, both personal and corporate, as much as possible.
If you’re struggling to make this decision for your company, then that likely means you don’t have a financial advisor who can help guide you in these types of complicated issues. You don’t necessarily need a full-time CFO – a virtual CFO is often a great option for most small businesses and startups. To learn how a virtual CFO can help grow your business, see here.