A small business that is registered as a Corporation has the option to make payments;
- as a regular salary
- paid by dividends
- or a mixture of both
There are advantages and disadvantages for each of these options a business owner needs to consider. The most important determining factor is how suitable it is to the small business financial picture. To understand the pros and cons of each, here is a basic layout how salary vs dividends work.
A corporation paying a salary provides you with a personal income. Deductions can be taken off your pay check for;
- Canada Pension Plan (CPP)
- Tax deduction for salary or bonus paid for the corporation
- Income splitting arranged by paying salary or related employees i.e: child or spouse
- Investment for retirement by contributing to a Registered Retirement Savings Plan (RRSP) or a Tax Free Savings Account (TFSA)
pros of receiving a salary
- Gives you a personal income
- Allows you to contribute to a retirement income
- A salary or bonus provides a tax deduction to your corporation
- Contribution to your CPP
Cons of receiving a salary
- A payroll account must be set up with monthly payments to CRA and file all related paperwork
- Both portions of CPP payment is required by Canada Revenue Agency (CRA) as an employer and employee
There are advantages and disadvantages to your corporations paying the small business owner dividends.
advantages paying dividends
- Taxes are at a lower rate than salary resulting in paying less personal tax
- Dividends can be declared any time during the year, allowing optimization of your tax situation
- No need to pay into CPP
- A much simpler procedure paying dividends that does not go through payroll. All that is necessary is the small business owner writes a cheque from their corporation. At the end of the year the corporation’s minute book is updated and a director’s resolution is prepared to show the amount of dividends paid.
disadvantages paying dividends
- Not paying into CPP can diminish the amount you are entitled to receive at retirement.
- You are not able to invest in any contributions towards a Registered Retirement Savings Plan (RRSP) as dividends are not recognized as income
- Since dividends are not seen as income like salary, this prevents making any claims as deductions on personal income tax for example childcare costs
receiving both salary and dividends
A third option is to receive both a salary and dividends. One way to stay within this limit is for a small business owner to receive a salary or bonus from their corporation because this reduces the company’s taxable income. A Canadian controlled private corporation (CCPC), situated in British Columbia, pays income tax at a low rate of 11% when income is below $500,000.
The decision to receive both salary and dividends depends on the small business owner’s personal financial situation. A few areas to consider;
- Income level
- Cash flow of the business
- Projected annual earnings
- Amount of cash investments and tax deductions
- Age of the small business owner
In order to make the right decision, it is best to receive professional advice from a Chartered Professional Accountant, a financial planner, or a tax lawyer. At Banka & Company, CPA we advise many corporate small business owners what is the best fit through discussions and reviewing their financial circumstances. Contact us to schedule an appointment to help you determine the compensation that is suitable to you and your business.