Salaries vs. Dividends – Corporate Accounting
Small business owners often want to find out, if they should be taking dividends from their corporation or paying themselves a salary. There are a few factors to consider in making this decision.
- Salaries reduce corporate taxes but create higher personal taxes than dividends.
- If you are paying yourself a salary or wage (same thing), the payments become an expense of the corporation and then employment income for you personally – you’ll get a T4. The expense reduces the corporation’s taxable income which reduces corporate taxes owing.
- Paying yourself a wage can be a way for you to earn a steady and predictable personal income.
- Dividends do not reduce corporate taxes, but create less personal taxes than wages.
- Dividends are payments to shareholders of a corporation that are paid from the after tax earnings of the company. This means that dividends are not a corporate expense and do not reduce the corporate taxes paid. The flip side is that dividends carry less personal tax liability than wages because they come with a dividend tax credit. The corporation must prepare and file T5s for any shareholders who received dividends.
- Paying dividends can be a simple way for business owners to withdraw money from their corporation.
Which one is better?
Paying yourself a salary can be a way for you to earn a steady and predictable personal income. Some key advantages of using this method include: RRSP contribution, CPP contribution, future planning of mortgage approvals.
Paying dividends can be a simple way for business owners to withdraw money from their corporation. Some key advantages include: lower cost no CPP contributions, no payroll remittances, easy and simple, if you own the corporation, declare a dividend and transfer cash from your company.
Want to Learn more about Corporate Income Tax – T2, click below
Drawbacks of Dividends
Dividends have two big drawbacks:
- First dividend income is not eligible income for CPP purposes. That means that if you graduated from high school, started a corporation and paid yourself nothing but dividends, when you turned 65 and applied for your Canada Pension, you would not get one.
- Second, dividends are not eligible income for RRSP purposes. The amount that you can contribute to an RRSP is based on your eligible income from prior years. Again, if paid yourself nothing but dividends, you would never be able to make an RRSP contribution.
Challenges of Paying Salaries
- Salary is just the pain in the butt factor. You have to remember to complete the remittance and pay the withholdings on a salary by the 15th of the following month and do the T4’s in February. With dividends you can do a T5 once a year and that is it.
- Also, whenever a Corporation pays a salary to a related person (the owner or owner’s spouse or children) you always have to consider the reasonableness of the salary in relation to the duties performed. If the CRA determines that a salary is not reasonable they could deny the deduction to the corporation while still taxing the recipient.
Speak with an accounting professional before doing anything to avoid negative tax consequences. Your accountant will
- advise you regarding the best way to personally compensate yourself and when the compensation should be paid.
- help you determine the amount and whether the compensation should be taken by salary, dividends or other benefits
CPA article Salaries vs Dividends https://www.cpacanada.ca/en/the-cpa-profession/financial-literacy/blog/2019/april/salary-dividends-integrative-cash-flow-planning