Is it better to take a Salary or Dividend?

Whether to take a salary or dividend from the corporation is a complicated decision that a small business owner usually has to make. This article indicates advantages of both alternatives so you can decide which option is beneficial for you!

Advantages of taking Salary

1. Increase your RRSP contribution limit

   By taking a salary from your corporation, you can increase your RRSP contribution limit. Hence, you will be able to make higher contributions and have greater saving for retirement. More RRSP contributions will also result in greater tax savings as they are deductible for tax purposes!

   To learn about other benefits of Retirement Savings Plan, visit http://www.tdcanadatrust.com/products-services/investing/rsps/rsp-index.jsp .

2. Increase your pension in retirement

   The Canada Pension plan, one the largest pensions available in Canada, offers pension income during your retirement years. By taking a salary you will be eligible to contribute to CPP and increase your pool to receive more CPP in retirement.

3. Deduct child care expenses

   When debating between salary and dividend, consider whether you employ a caregiver to look after your children. Child care expenses are deductible for tax purposes, but the deduction is generally limited to two-thirds of the lower-income spouse’s “earned income”. Earned income includes employment income, but not dividend income. Hence, if you want to reduce your taxes by taking advantage of the child care deduction, you may consider taking a salary. A common tax strategy is to take enough salary to only utilize this deduction and take the balance as dividends. This will provide tax savings for you on both the personal and corporate level.

   To read more about child care expenses, visit http://www.cra-arc.gc.ca/tx/ndvdls/tpcs/ncm-tx/rtrn/cmpltng/ddctns/lns206-236/214/menu-eng.html .

4. Reduce corporate tax payable

   As salary paid is an expense incurred to earn business income, it can be deducted to reduce the company’s taxable income, thus resulting in lower taxes!

Advantages of taking Dividend

1. Increase after-tax cash flow

   Dividends paid do not have source deductions, such as CPP, EI or income tax. As a result, you have more cash-flow available for your personal use. With the dividend tax credit on dividends, you only have to pay excess taxes on your personal tax return based on your marginal tax rate.

2. Less Administration Work

   Taking salary as compensation involves a great deal of administrative work as CPP, EI, and Income taxes are required to be remitted to the CRA every 15th of the month. If the source deductions are not remitted on time, CRA may charge penalties and interest.

3. Tax-free dividends (ineligible) up to $40,000

   In the province of Ontario, if you have no other sources of income, the first $40,000 in dividends can be received by an individual tax-free. You are only required to pay a small health premium of approximately $600.

4. Greater Flexibility with Income Splitting

   Splitting income with family members via dividends is more flexible than paying salary as employment income provided has to be reasonable. In contrast, dividends are not subject to this reasonability test, thus allowing higher income amounts to be transferred to the individual in the lower tax bracket.

   To learn more about income splitting, please visit http://madanca.com/blog/accountant-toronto-tax-tip-income-splitting-with-spouse/ .

5. Increase your income for loan approvals

   As part of the loan approval procedure, financial institutions generally require a certain amount of income to be reported on the candidate’s personal tax return. Unlike salary, dividends are grossed up 25% to represent the pre-tax amount. As a result, net income on the borrower’s personal tax return will be higher than the actual amount of cash-flow that was paid out. This can increase the possibility of receiving loan approval from the financial institution.

   To learn more about whether to take salary or a dividend, please visit http://madanca.com/blog/should-i-pay-myself-salary-or-dividends-from-my-corporation-as-a-business-owner/ .

ABOUT THE AUTHOR

ALLAN MADAN

CPA, CA

Allan Madan is a CPA, CA and the founder of Madan Chartered Accountant Professional Corporation. Allan provides valuable tax planning, accounting and income tax preparation services in the Greater Toronto Area.

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