Salary vs. Dividends for Incorporated Business Owners

How should you pay yourself from your corporation?

Your corporation made money. Now comes an important question:

How should you take that money out?

For many incorporated business owners, the two most common options are salary and dividends.

Both can put money in your hands, but they do not work the same way.

They can affect your personal taxes, CPP contributions, RRSP contribution room, corporate deductions, and even your cash flow planning.

The right approach is not always “salary” or “dividends.” In many cases, it may be a combination of both.

Salary: Paying Yourself as an Employee

When your corporation pays you a salary, the salary is generally a corporate expense.

That means it reduces the corporation's taxable income, provided the amount is reasonable for the work performed.

For you personally, report the salary as employment income.

Salary also creates RRSP contribution room for the following year, subject to the applicable limits. It generally requires CPP contributions, with the corporation paying the employer portion and the individual paying the employee portion.

The corporation will normally need to operate payroll, make the required source deductions and remittances, and issue T4 after year-end.

Salary may therefore make sense when you want to:

· build RRSP contribution room;

· continue adding to CPP;

· establish a regular and documented personal income;

· decrease taxable income inside the corporation; or

· create a predictable monthly paycheque.

But salary also means payroll administration and potentially significant CPP costs.

Dividends: Receiving a Return as a Shareholder

A dividend works differently.

Instead of being paid because you are an employee, you receive the dividend because you are a shareholder.

Corporations generally pay dividends from after-tax income. Unlike salary, they are not deductible in calculating the corporation's taxable income.

At the personal level, dividends receive different tax treatment from salary through the dividend gross-up and tax credit system.

Dividends also do not create RRSP contribution room and generally do not attract CPP contributions.

For some business owners, that makes dividends attractive because there are no CPP premiums on the dividend itself and payroll can be simpler.

But you need to weigh those advantages against what you give up.

If you rely entirely on dividends, you generally will not build RRSP room from those dividends, and you won't make CPP contributions on that income.

So, Which One Is Better?

No single answer fits every incorporated business owner.

Consider two owners with corporations earning similar amounts.

One may be trying to maximize RRSP contributions and build CPP participation over the long term. Salary may play an important role.

Another may already have substantial retirement savings, does not need additional RRSP room, and prefers to leave more money inside the corporation. A different salary-dividend mix may make sense.

A third owner may use both salary and dividends.

That is why the decision should not be based only on one question:

“Which one gives me the lowest tax bill this year?”

A better question is:

“What is the most appropriate way to pay myself based on my business, personal cash needs, taxes, and longer-term plans?”

Before Deciding, Look at the Bigger Picture

Before choosing salary, dividends, or a combination, consider:

How much do you actually need personally?

Taking more money out of the corporation than you need may create personal tax sooner than necessary.

Do you want to build RRSP contribution room?

If RRSP savings are part of your retirement plan, salary can matter because dividends don't create RRSP room.

How important is CPP to your retirement plan?

Salary usually means paying into CPP, while dividends generally do not.

How much cash does the business need to keep?

Before taking more money out of the corporation, look at what the business needs to pay in the coming months. Set aside enough for income taxes, GST/HST, payroll, loan payments, equipment or other planned purchases, regular operating costs, and day-to-day cash needs.

Paying yourself is important, but so is making sure the business has enough cash to meet its obligations and keep operating comfortably.

What other income do you have?

Your salary-dividend decision should be considered together with your spouse or household situation where relevant, investment income, other employment income, RRSP deductions and other personal tax factors.

Don't Wait Until Tax Filing Time

One common mistake is deciding how to characterize shareholder withdrawals only after taking the money out of the corporation.

Throughout the year, amounts paid to or withdrawn by a shareholder should be properly identified and recorded.

Is it salary?

A dividend?

A reimbursement of business expenses?

Repayment of money the shareholder previously advanced to the corporation?

Or a shareholder loan?

These are not interchangeable. Each can have different accounting and tax consequences.

Good planning starts before the money leaves the corporation, not when you're preparing the corporate tax return.

The Practical Approach

For many owner-managed corporations, the question is not simply

Salary or dividends?

The most useful discussion is:

How much should I take out, when should I take it, and what combination fits my situation?

Your corporation and your personal finances are connected, but they are not the same thing.

Before deciding how to pay yourself, review the corporation's profit, available cash, taxes owing, shareholder loan balance, personal cash needs, retirement plans, and other income sources.

A well-planned compensation strategy can help you take money from your corporation deliberately rather than simply withdrawing cash whenever you need it.

T3M Consulting
People. Plans. Possibilities.

Accounting • Tax • Business Advisory • Financial Planning

You worked hard to build your business. When it’s time to pay yourself, the decision deserves more thought than simply transferring money from the corporate account to your personal account.

Before you take money out, let’s look at the numbers together.

We can review what your corporation can comfortably afford, what you need personally, and how salary, dividends, or a combination may fit into your tax and longer-term financial plans.

If you’re not sure how much to pay yourself—or how to pay it—let’s have that conversation before you make the withdrawal.

This article provides general information only. The right mix of salary and dividends depends on your business and personal situation. Speak with a qualified tax or financial professional before making decisions based on your circumstances.