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As a business owner in Canada, one of the crucial decisions you'll face is how to pay yourself – through salaries, dividends, or a combination of the two. Each method has its own set of advantages and disadvantages, and understanding the differences and reporting requirements is essential for making informed financial decisions.
Firstly, it is important to understand that there is a tax concept called integration
within the Canada’s tax system. This concept aims to ensure that the total tax burden on income earned through dividends and wages is roughly equal with the goal that this decision is driven by financial considerations rather than tax avoidance. Because of this, in this blog post, we will be looking at the tax implications but also personal financial goals, the corporation’s profitability needs, retirement planning, and more.
What is a Salary?
Salaries or wages are a regular payment to yourself as an employee of your own corporation. These payments would have tax withheld at the source and be on a regular schedule.
Advantages:
Steady Income: Salaries provide a predictable, regular income stream, which can be particularly helpful if you rely on your business for your livelihood.
Contributions to CPP: When you pay yourself a salary, you contribute to the Canada Pension Plan (CPP). This ensures you're eligible for these benefits in the future.
Tax Deductibility: Business expenses, such as salary payments, are tax-deductible, reducing your corporate taxable income.
Fewer “surprise” tax bills: since you are paying income tax on each pay, when you file your personal tax return you likely won’t owe a balance.
RRSP Contribution Room: paying yourself a wage will allow you to build RRSP contribution room.
Personal Credit: banks often look at wages as more stable than dividends. If you are planning on applying for a personal mortgage or any other personal loans, banks will look at this as more favorable.
Childcare Deduction: Child care expenses are claimed on the lower income spouse. Dividends are not include in this calculation. If you show $0 income you could lose this deduction.
Disadvantages:
Administrative Burden: Managing payroll, remitting payroll deductions, and filing T4 statements can be administratively burdensome.
Less Flexibility: Since wages are set on a regular schedule, wages can be more difficult if you project cashflow issues.
Reporting Requirements:
When you pay yourself a salary, you need to:
Register for a Payroll Account with the Canada Revenue Agency (CRA).
Deduct and remit CPP contributions from your salary.
File T4 slips with the CRA by the end of February each year.
What are dividends?
Dividends involve distributing profits to shareholders as cash becomes available, no set schedule and no taxes are withheld.
Advantages:
No CPP Contributions: Unlike salaries, dividends do not require contributions to CPP, reducing your overall payroll costs.
Simplified Administration: Dividends are simpler to administer compared to a payroll system, which can be advantageous for small business owners.
Payroll Penalties: CRA continues to increase the payroll penalties. If you are late remitting, there could be large penalties. Dividends don’t have the same regular reporting requirements.
Disadvantages:
Irregular Income: Dividends are based on your corporation's profitability, so the amount can vary from year to year, making it less predictable.
Limited CPP Benefits: Receiving dividend
Dividends may affect your future CPP benefits since they do not contribute to the CPP program.
Reporting Requirements:
When you pay yourself dividends, you should:
· Report dividend income on your personal tax return (T5 slip).
In the dynamic landscape of business ownership, the decision of how to pay yourself is not a one-size-fits-all matter. As your personal goals shift and your business evolves, reassessing your compensation strategy becomes a crucial component of financial stewardship. Whether opting for the predictability of salaries or the flexibility of dividends, understanding the tax implications, administrative demands, and long-term effects on your financial well-being is paramount. Continuously revisiting this decision ensures that your compensation strategy remains aligned with your ever-changing aspirations, ultimately contributing to the sustained success of both you and your business.
How will you be compensating yourself?
Salary
Dividend
Combination of the two
Questions? Contact us at 506-455-5397.
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