A frequently asked question from business owners is whether they should pay themselves a salary or dividends. Depending on your business and personal situation, one compensation method may be better suited than the other or your professional accountant may suggest a combination of the two.

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Salaries

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To pay yourself a salary or wages from your company, you will first need to register for a payroll account with CRA. This account is how the CRA tracks the source deductions that you will be required to remit (income taxes, CPP, and EI—if applicable). Each time you pay yourself, you will need to calculate the amount of tax and other deductions to withhold and remit to the CRA.

Salaries become an expense of the company as they are paid to the business owner before the corporate taxes are calculated. This results in lower net income and ultimately lower corporate taxes.

Following the calendar year, a T4 slip must be prepared so that the business owner can report the income and tax withholdings on his or her personal income tax return. The deadline for filing T4’s is February 28th.

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Unfortunately, the decision to pay salary or dividends is not a black and white answer.

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From the personal side, there are some benefits to paying a salary. Salaries create RRSP contribution room, which can be an important part of an individual’s retirement savings. Salary and wages also require contributions to the Canada Pension Plan (CPP). The contributions you make now will be a benefit in the future when you collect your CPP.

Another benefit to salary is that you are sending in taxes to the CRA throughout the year. If saving for taxes is not your strong suit, then this might be the preferred option, as there is less likely to be a surprise tax bill when you file your personal income taxes.

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Dividends

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Dividends, on the other hand, are paid to a business owner after corporate taxes have been paid. They are not an expense for a company, but rather a distribution of the company after-tax earnings. Because the company has already paid tax on this money, the personal tax rate is less with dividends.

Dividends are relatively easy to pay. You can pay yourself in a series of payments or in a lump sum amount. A dividend resolution will be prepared to update the corporate minute book, and a T5 slip will be prepared for reporting on your personal income tax return.

A major benefit of dividends is that there are no regular remitting requirements, so you don’t have to worry about remitting your source deductions late to the CRA and having to pay interest and penalties.

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Conclusion

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Unfortunately, the decision to pay salary or dividends is not a black-and-white answer. It is something that you will want to discuss with your accountant, as it is important to consider both your personal and business situation. Your tax advisor may also decide that a combination of the two provides the greatest benefit by utilizing the tax planning advantages of both methods. Give me a call or send me an email if you would like to discuss what the best compensation method is for you and your business.

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