March 17, 2020

When to pay Salary or Dividends?

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This is a question we get asked fairly often by owners of Canadian Incorporated (Inc.) or Limited (Ltd.) companies, “Should I be paying myself with Salary or Dividends?”. Here are some of the common considerations when deciding to pay yourself with Salary or Dividends as a small business owner in Canada.

What is the difference between Salary and Dividends?

First, it’s important to note the difference between salary and dividends. Now that you are operating an incorporated company in Canada, you are BOTH the Shareholder of the company and an Employee of the company. A Shareholder gets paid after-tax profit distributions in the form of Dividends. An Employee gets paid a Salary. You can be both and you can be paid one, or the other, or both. This is a discussion for you to have with your tax accountant.

CPP Premiums on Salary and Dividends

One difference with Dividend income is that it doesn’t have CPP premiums assessed on it. Salary income does attract CPP premiums, up to a maximum of $5,796 combined Employee and Employer contributions on $58,700 of Salary income or higher. This is either a pro or con depending on how you look at it. If you don’t care about CPP pension income in the future (i.e. you have other forms of retirement savings) then you may not care about paying in to CPP right now. Paying yourself a salary would have CPP deductions on your paycheques, but it also contributes to what you can receive as CPP benefits in retirement, so paying CPP premiums now is not necessarily a bad thing.

RRSP Contribution Room on Salary and Dividends

Taking Dividend income does not increase your RRSP contribution room. Salary does because it is considered “Employment Income”. Some people prefer Salary because they are close to the maximum contributions on their RRSP accounts and they want to continue building up retirement savings in their RRSPs. You need to keep taking Salary in order to increase your RRSP contribution limit as this is considered “Employment Income” and Dividend income is not, it’s “Investment Income”. If you are not interested in contributing to RRSPs this may not be a concern for you. You should discuss this point with your Financial Advisor.

Childcare Expenses as a Tax Deduction when Earning Salary or Dividends

If you are part of a couple with young kids, you need to have both spouses earning Employment Income to be able to deduct Childcare Expenses on your personal tax return. If one spouse is not working or doesn’t have Employment Income (due to only taking their business income in the form of Dividends) you may miss out on claiming Childcare Expenses such as daycare fees or preschool fees. If you do not have kids in daycare or preschool, this is not a concern for you. To this point, you may want to pay yourself a small amount of Salary, say $15,000 or $20,000, and then take the rest of your earnings in Dividends.

Qualifying for a Mortgage or Renewing a Mortgage when you are Self-Employed

Are you planning to buy your first home or will you need to renew your mortgage soon while you are self-employed? We have heard from a few Mortgage Brokers that lenders are much more favourable to Salary income as opposed to Dividend Income. If you will need to renew your mortgage soon, then it may be a good idea to take your personal income as Salary, not Dividends. This would be a good point to discuss a year or two ahead of your application or renewal deadline with your Bank Lender or Mortgage Broker. Talk to this person now if you are currently saving for your first home.

Salary as a Business Expense

One advantage to paying a Salary to the Business Owner is that it is a business expense that brings down the taxable income of the Incorporated company. Dividends are after-tax distributions of the leftover profits, so they are not a business expense. But, on the other hand, the Salary also becomes personal income that you’d have to pay taxes on the paycheques, so this point may require some tax planning projections to be able to accurately estimate the benefits of salary versus dividends in your situation. Some business owners like the security of a monthly regular paycheque and want to have their company paying the Source Deductions (payroll income taxes and CPP premiums) on their behalf monthly. This is easier on the company cashflow than having no taxes deducted from paycheques all year and having to pay a lump sum of tax at the end of the year when you file your personal tax return.

Small Business Limit for Discounted Tax Rate

Canadian Controlled Small Business Corporations in Canada earning under $500,000 of annual profit benefit from a special reduced corporate tax rate. This may sound like an unattainable amount of profit right now, but if you find yourself in the position where your business is getting close to this level of profit, you will want to make sure that your total profit stays under this limit. This is where a tax strategy called “Bonusing down” can be used. The owner of the business would pay themselves a salary high enough (or a year end bonus to adjust) to keep the incorporated business profit under $500,000 for the year, because their Salary is a Business Expense.

We hope that this information helps you to make a better informed decision about whether to pay your self Salary or Dividends from your Canadian small business!