How to Pay Yourself From Your Corporation Canada
As a small business owner in Canada, one of the critical decisions you need to make is how to pay yourself from your corporation. Should you opt for a salary or dividends, or perhaps a combination of both? This dividends vs salary choice will have implications for your taxes, retirement savings, and overall financial strategy. In this article, we will explore the advantages and disadvantages of dividend vs salary. We will make sure to provide you with the information you need to make an informed decision.
Understanding Salary and Dividends
Before we delve into the details of salary versus dividends, let’s first define what salary and dividends are in the context of incorporated small business ownership. A salary is a fixed amount of money paid to an employee on a regular basis, typically monthly or bi-weekly. It is considered employment income and is subject to income tax deductions, Canada Pension Plan (CPP) contributions, and Employment Insurance (EI) premiums (although small business shareholders are generally exempt of EI). On the other hand, dividends are payments made to shareholders of a corporation, including the business owner. Dividends are derived from the profits of the corporation and are considered investment income. They are taxed differently from employment income and do not require CPP contributions or EI premiums.
Paying Yourself a Salary
One option for small business owners is to pay themselves a salary. There are several advantages to this approach.
First, a salary provides you with a legally recognized personal income, which can be important when applying for a mortgage or a bank loan. Having a steady salary also makes it easier to plan and budget your personal finances. Additionally, a salary allows you to contribute to the CPP and accumulate RRSP contribution room. These retirement savings vehicles can provide you with long-term financial security.
The decision to pay yourself salary or dividend can also impact the availability of the child care expenses deduction. Only salaries qualify as earned income in the calculation of the child care deduction.
However, there are also some considerations to keep in mind when opting for a salary. One disadvantage is that salaries are subject to higher taxes compared to dividends. Salaries are considered employment income. Therefore, they are taxed at the individual’s personal income tax rate which tends to be higher than the corporate tax rate.
However, this is offset by the fact that salaries are one of the deductible business expenses available to small businesses in the calculation of taxable income. Another downside is the administrative burden of payroll, as you will need to register a payroll account with the Canada Revenue Agency (CRA) and make regular remittances for income tax, CPP, and EI. This can add complexity to your financial management. Thankfully, there are tools such as Wagepoint and Knit that can assist with this additional compliance requirement
Paying Yourself Dividends
Alternatively, you may choose to pay yourself dividends as a small business owner. Dividends offer certain advantages, including tax savings and flexibility. Dividends are taxed at a lower rate than salaries since they are derived from corporate profits, which have already been subject to corporate taxes. This can result in lower overall tax obligations for business owners. Dividends also provide more flexibility in terms of cash flow management, as you are not required to make regular payroll remittances.
However, there are some considerations to keep in mind when opting for dividends. Unlike salaries, dividends do not contribute to CPP or generate RRSP contribution room. This means that you will need to have alternative retirement savings strategies in place. Dividends also do not qualify for certain government subsidies and tax credits that are available to salaried employees. Additionally, paying yourself dividends may have implications for mortgage applications, as banks often prefer to see consistent, predictable income.
Salary vs Dividend – Finding the Right Balance
The decision between salary and dividends is not necessarily a binary choice. Many small business owners find it beneficial to strike a balance between dividends or salary. Not limiting yourself to dividends versus salary and instead opting to paying yourself a dividend and a salary is also a valid option. This approach allows you to take advantage of the benefits of each while mitigating their respective drawbacks. By paying yourself a combination of salary and dividends, you can optimize your tax situation, maintain a consistent income stream, and contribute to both CPP and RRSPs.
Determining the right balance between salary and dividends requires careful consideration of your individual circumstances. Consider factors like business profitability, personal financial goals, and potential impact on your retirement savings. Consulting with a qualified tax professional or financial advisor can help you navigate the complexities and make an informed decision when it comes to the right mix of dividend or salary.
How Much Dividends Should I Pay Myself?
A common question that comes up with small business owners is how much dividends can I pay myself? Unfortunately, there is no one-size-fits-all answer to establishing how you should be paying yourself from your business, as it depends on various factors such as your business’s profitability, your personal financial needs, and your tax situation. However, there are some general guidelines that can help you determine an appropriate amount you should be paying yourself in dividends.
After-Tax Profits
First, when a business owner is wondering how much dividend can I pay myself, it’s important to ensure that his business has sufficient profits to distribute. Dividends are paid out of the after-tax profits of the corporation, so you should consider the financial health of your business before deciding on a dividend amount. It’s generally recommended to consult with a tax professional or accountant who can help you analyze your business’s financial statements and determine a reasonable amount to pay yourself in dividends.
Personal Financial Needs
Another factor to consider is your personal financial needs when you decide to pay yourself dividends. A regular income stream should be assessed against your living expenses and financial obligations. It’s important to strike a balance between paying yourself a reasonable dividend and leaving enough profits in the business for future growth, reinvestment, and tax obligations.
Tax Implications
Additionally, when you pay yourself dividends, you should be mindful of the tax implications. Dividends are taxed at a lower rate than salaries, but they are still subject to personal tax. The tax rates for dividends vary depending on your personal income tax bracket and the type of dividends received. Additionally, because your small business will not be able to deduct a salary as an expenses, there will be additional tax payable in the corporation. Consulting with a tax professional can help you maximize tax savings and ensure compliance with tax regulations.
How to Pay Yourself Dividends?
Once you have determined that you should be paying yourself dividends, there are several steps you need to follow so you can actually pay them. Firstly, your business must be structured as a corporation, as only corporations can distribute dividends. Once you’ve confirmed this, you’ll need to determine the amount of profit available for distribution by reviewing your financial statements and consulting with your accountant. Once the amount is determined, you’ll need to hold a meeting of the board of directors to declare the dividend and document it in the meeting minutes. Afterward, you can issue dividend checks or transfer the funds to the shareholders’ bank accounts. From an accounting perspective, it’s important to record the dividend payment in your company’s financial statements.
When it comes to tax implications, dividends are subject to tax in the hands of the shareholders. The tax rates for dividends vary depending on the type of dividend and the individual’s tax bracket. It’s crucial to understand the dividend tax rates and any applicable tax credits or deductions that can help minimize the tax burden. Seeking guidance from a tax professional or accountant is highly recommended to ensure compliance with tax regulations and maximize tax savings. They can provide valuable advice tailored to your specific situation and help you navigate the complexities of dividend taxation in Canada.
Can you Pay Yourself Dividends Monthly?
Yes, it is possible to pay yourself dividends monthly from your business in Canada. However, there are several factors that need to be considered before making this decision. Firstly, you need to ensure that your business has sufficient profits to distribute as dividends. Consulting with a tax professional or accountant can help you analyze your business’s financial statements and determine a reasonable dividend amount. Additionally, you need to consider your personal financial needs and strike a balance between paying yourself a reasonable dividend and leaving enough profits in the business for future growth and tax obligations. Lastly, it’s important to be mindful of the tax implications of paying yourself dividends and consult with a tax professional to maximize tax savings and ensure compliance with tax regulations.
Salaries vs Dividends – Small Businesses Filing Requirements
When a small business owner decides to pay themselves salaries or dividends, there are specific filing requirements that need to be followed. If the business pays salaries to its owners, it must issue T4 slips to report the income and deductions withheld, such as income tax, CPP contributions, and employment insurance premiums. These T4 slips are provided to both the owners and the Canada Revenue Agency (CRA). On the other hand, if the business pays dividends to its owners, it must issue T5 slips to report the dividends paid. These slips are also provided to both the owners and the CRA. It’s important to ensure accurate and timely filing of these slips to comply with tax regulations and avoid penalties. Seeking guidance from a tax professional or accountant is highly recommended to ensure compliance with these filing requirements.
Conclusion
In conclusion, the decision of whether to pay yourself a salary vs dividends as a small business owner in Canada requires careful consideration of various factors. Both options, salary and dividend, have their advantages and disadvantages, and finding the right balance for your specific circumstances is crucial. Consulting with a tax professional or accountant can provide valuable insights and guidance in navigating the complexities of payment methods, tax obligations, and retirement savings. Ultimately, the goal is to optimize your personal finances while ensuring the financial health and growth of your business.
Seb Prost, a CPA with over 10 years of experience in taxation and accounting, offers a unique blend of insights from his time at the CRA and his experience in public practice. Originally from QC and now based BC, he specializes in guiding Canadian businesses for all of their accounting and taxation needs.
