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PricingService areasAll services →Dividends vs. Salary: How to pay thyself from your own Corporation?
By Wajahat Ajmal
Table of Contents
Many of our clients, who are business owners, usually ask us this question: How should I pay myself?
Now, if you have a corporation, there are several ways which you can deploy to pay yourself:
- Salary: A compensation, also known as wage or employment income, paid either by the hour or monthly.
- Dividends: An amount of benefit paid to the shareholder of a corporation.
- Mix of both: Combination of salary and dividends used to pay thyself.
This article will be slightly longer than usual and will highlight key differences between salary and dividends, the pros and cons of each and simple situations where one can be preferred over the other.
Slips issued under Salary and Dividends:
If you receive an employment income, you will be issued a T4 slip, whereas if you receive a dividend, you will be issued a T5 slip. Both of these slips are then reported in your personal tax return.
Features of Salary/Wage:
Nature of this transaction:
Salary is treated as an expense for the corporation, unlike dividend.
This reduces the corproation’s tax payable.
Requirements needed to pay yourself a salary:
To pay yourself a wage, the first requirement is that the corporation should have a payroll account setup with the CRA. Once this is done, from every gross salary that is to be paid, a corporation is required to make some source deductions, also known as withholding taxes, such as CPP and income tax, from the wages and pay the net wage.
The source deductions should then must be sent, on regular intervals, to the CRA (Receiver General). Moreover, the corporation will also have to issue all of the employees T4 slips and will also have to file a T4 Information Return with the CRA.
Benefits of paying a salary over dividends:
Apart from being a regular and predictable income, there are some other benefits that entail a salary:
Salary creates RRSP Contribution Room and allows CPP Contribution, unlike Dividends:
Source deductions create fewer tax bills:
When you pay yourself a salary, income tax is deducted from each payment and sent to the Receiver General. As a result, by the time you file your personal tax return, the income tax on your earnings has already been paid, and in most cases, results in a refund to you upon personal tax filing.
This approach helps you avoid unexpected personal tax bills when filing your return. On the other hand, dividends do not involve tax deductions at the time of payment. This often leads to personal taxes being due in April when you file your return.
A surprise tax bill is a common issue, especially for those new to receiving dividends.
Salary is preferred by the Banks:
If you are planning to apply for a mortgage, banks tend to prefer a steady source of income, like wages, and prefer that our dividends. This allows you to qualify much easily for a mortgage.
If you are planning to buy a home in the future, it might be preferable to pay yourself a salary.
Features of Dividends:
Dividends are paid from after-tax earnings of the corproation. Dividends, therefore, do not reduce the taxable income of the corporation.
On the personal income tax side, a dividend tax credit is provided. More on this below.
How to pay dividends?:
Unlike salary, paying dividends is fairly easy. There is no calculation required for CPP and income tax as there are no source deductions involved.
You just take out the money from the corporation and transfer it to your personal account. Then you declare it as a dividend. It could either be a single transaction or bunch of transations. The corporation, though, will have to file a T5 Information Return with the CRA on the complete amounts taken out during the year as a dividend and will also have to issue the shareholder(s) with a T5 slip. You will also have to create a dividend resolution. This is where lawyers help.
Dividend can only be issued to a Class of shares. If there are multiple owners owning a similar Class of shares, then dividend issued will be distributed among them based on the percentage of Class of shares owned.
Example, Mr. Obama owns 60% of Class A shares in Trump Dump Inc. and 40% shares are owned by Mr. Clinton.
Trump Dump Inc. annoucnes dividends of $100,000 on Class A shares. Now, from this amount 60% will be recieved by Mr. Obama and 40% will be given to Mr. Clinton.
Dividends do not entail penalties or fines on late payments:
Paying wages means that you need to remit source deductions in a timely fashion to the CRA. if you do not, you face stiff penalties.
There is non of that here!. Paying dividends eliminates this. The only caveate is that you need you need to file T5 Information Return with the CRA on time once per year when you issue dividend. Late-filing this does entail a fine.
No health tax?:
In some provinces, some employers are required to remit health taxes as well (BC, ON and MB). Paying dividends to the owners eliminates this requirement or reduces it as this is applicable to wages only.
What is the best way to pay yourself from the Corporation to minimize tax burden?:
The honest answer is that it depends. Since the changes to the legislation in the early 2018, have made it more difficult to reduce taxes by paying yourself in either method. Now the calculations show minimal tax savings in either model and there are good reasons as to why, which have been detailed below.
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Rates used: Federal small business rate (net): 9% (source); Ontario small business (lower) rate: 2.2% (source); Business limit (small business deduction): $500,000 (source); Non-eligible dividend gross-up: 15% (source); Federal dividend tax credit, non-eligible (% of taxable amount): 9.0301% (source); Ontario dividend tax credit, non-eligible (% of taxable amount): 2.9863% (2026) (source); CPP rate (employee and employer, each): 5.95% (source); YMPE: $74,600 (source); CPP2 rate (each): 4% (source); YAMPE (CPP2 ceiling): $85,000 (source); Federal basic personal amount (maximum): $16,452 (source); Ontario basic personal amount: $12,989 (source); Federal brackets (up to, rate) (source); Ontario brackets (up to, rate) (source).
The concept of Integration:
hThe legislation in Canada aims to ensure that at the overall level , the amount of income tax paid (corporate tax + personal tax) is similar irrespective of the fact whether a wage is paid or a dividend. This is integration concept which the legislation aims to implement.
Lets explore this in a bit more detail.
Here is how the taxes will look like if you earned $100,000 either as a salary or dividend:
Its evident that at $100,000 it tends to be cheaper paying dividends but lets see how it looks at $150,000:
Now the taxes are more at this level. This is the most simple example that does not take everything into account. There are other factors that could affect the outcome which have not been factored here.
Dividend sprinkling:
So pre-2018, there was a way to reduce your taxable income, where you paid your lower-income earning spouse or an adult family member a dividend and reduce the overall tax liablity that was payable. This was known as dividend sprinkling.
Now it has become a lot more difficult to do so. The government bought in Tax on Split Income or TOSI for short in 2018 and made it more difficult to implement this strategy.
You can learn more about it in our article here: Tax on Split Income
So, in summary:
It is better to pay salary if you are planning to have RRSP room, receive CPP when you are older and also want to receive Maternity or Parental benefits. Source deductions also contribute towards insurance premiums which then enables employee to claim those benefits. It is also beneficial if you want to qualify for mortgages and reducing corporate taxes. You can also pay a combination of both.
