When is it better to pay a salary vs. a dividend as the owner/manager of a corporation? There are pros and cons to each method and as the owner of a business you should be aware of your options before deciding on what is better for your unique tax situation and why. The following article will help you understand the difference between your options and why one might be better for your tax situation.
Salary – Pros
- Salary is considered employment income which will increase RRSP contribution room and allow you to contribute to CPP.
- Paying a salary allows the owner to take advantage of certain personal tax deductions, such as childcare expenses.
- When a bonus is declared at year-end there is the opportunity for a personal tax deferral since the salary does not need to be paid for 6 months.
- Declaring a salary can reduce corporate taxable income and is used in tax planning to decrease income below the $500k small business limit or so the company has nil taxable income.
Salary – Cons
- If the company is considering obtaining financing, it could be affected since a salary would decrease the financial results of the company.
- If a bonus is declared and not paid right away, some people run into issues 6 months later if they have cash flow issues and are unable to pay the bonus at that time.
- Salaries do not have a preferential tax treatment so they will likely pay more personal tax than if a dividend is declared.
- Paying a bonus or salary comes with a higher cost, since you must factor in employer and employee portions of CPP.
- There are more compliance costs and hassles because of operating a payroll account.
Dividends – Pros
- Earning dividend income personally has a preferential tax rate.
- If the company is considering obtaining financing for the business, having a higher net profit on the financial statements would be preferable to show potential lenders that the company is more profitable.
- Depending on the year-end of the company, declaring a dividend could provide a personal tax deferral till the personal tax deadline in April.
- It is easier to pay a dividend than a salary (no source deductions required).
- Dividends can be declared at any time, allowing the you to optimize your tax situation.
Dividends – Cons
- Earning dividend income does not create RRSP room nor will the you be contributing to CPP.
- Declaring a dividend does not provide a deduction to reduce corporate income.
- The taxpayer would loss out on certain personal tax deductions if no salary is earned, such as childcare expenses.
There is no easy answer to which is better between salary and dividends. The answer depends on each taxpayers’ preferences, how much cash you require personally from your company, corporate tax results, personal tax deductions, and retirement planning. If you are struggling to determine which method is best for you or would like assistance with analyzing your tax situation, this is where we come in. After assessing your life situation and goals, we are be able to point you into the right direction, so you are set for success!
Contact Argento CPA today!