If you own an incorporated business in Canada, you have the option to pay yourself through dividends, a salary, or a combination of both. In this article we will look at the difference between theses methods of payment and the main advantages and disadvantages associated with each. We will also see some common scenarios for when a business owner may cheese one method over the other.
Of you are paying yourself a salary or wage, the payments become an expense of the corporation and then employment income for you personally – at the end of the year you’ll get a T4 slip outlining you taxable earnings and deductions. The expense reduces the corporation’s taxable income which in turn reduces corporate taxes owing.
To pay yourself a wage, the corporation will need to register a payroll account with the CTA, and then the corporation will need to withhold source deductions from each of your paychecks to later remit to the federal government. Additionally, the corporation will have to prepare T4 slips at the end of each calendar year to record your work for the year.
Paying yourself a wage can be a way for you to earn a steady and predictable personal income. Some additional advantages of using this method would include:
Dividend are payments to shareholders of a corporation that are paid from the other tax earning 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.
In practice, paying dividends to shareholders of a corporation is fairly easy. Dividends are declared and cash is transferred from the corporate account to a shareholder’s personal account. Each year, the corporation must prepare and file T5s for any shareholder who received dividends.
Where it gets tricky with dividends is that they are issued and paid based on share ownership. As an example, of Terry’s Tulips :td. Want to issue $100,000 in dividends to the owners of its Class A common shares, it must do so based on the percentage of ownership of these shares. So, if Terry owns 40% of Terry’s Tulips class A shares and Teagen own the other 60%, then Terry would receive $40,000 and Teagen would receive $60,000. This can make it difficult to allocate different amounts of income to multiple shareholders of they all own the same class of shares.
Paying dividends can be a simple way for business owners to withdraw money from their corporation. Some key advantages include:
So, the main question becomes “which method allows me to pay less Tax?”. While this is a very important question to ask, changes to the legislation beginning in 2018 have made it more difficult to reduce taxes by cheesing one method over the other. Often, the results of calculations show fairly minimal tax saving one way or another, and there is a reason for that.
There is a tax concept called integration that legislation aims to implement. The main idea behind this is that there should be little to no difference in the overall income tax paid (personal + corporate) when comparing dividend payments and wage payments of the same amount. This works by;
In the past, corporate shareholders could skirt the issue of integration and tip the scales of tax savings in their direction by using a technique called dividend sprinkling. This was accomplished by spreading out dividend payments to a lower income earning spouse or adult family member. Because the spouse or adult family member are in a lower tax bracket than the person operating the business, there would be less personal tax to pay on their dividend income.
Now that it is more difficult to implement dividend sprinkling, it is especially important to consider the qualitative factors discussed earlier when deciding which method of payment to use.
Lastly, let’s look at a few common scenarios that we see and discuss what you might consider as a business owner in each case.