Salary vs. Dividend Income

Salary vs Dividend Income – For Small Business

A general question among business owners is whether they should draw salaries vs. dividends from their Canadian Controlled Private Corporation (CCPC).

Types of Compensation

You can receive a salary or dividend or both as an employee and a shareholder of a Canadian-Controlled Private Corporation (CCPC). The most tax-efficient compensation will depend on the various facts about your and your corporation's financial situation.

Salary Compensation

• Salary is a deductible expense

Salary is a deductible expense for income tax purposes. The salary paid by your corporation will lower the corporation's taxable income.

• Register a Payroll Account

The corporation must register a payroll account with CRA if salaries are paid. The corporation must withhold income tax and CPP and remit to the CRA regularly. Furthermore, each year, the corporation must prepare and file T4s for employees that earned wages and submit yearly reporting to CRA.

• Salaries allow for CPP Contributions

As mentioned, salary will allow you to contribute to CPP. When paying a salary, the corporation must then remit the withholding taxes and employee and employer portion of CPP monthly to CRA. The maximum CPP contribution required in 2022 is $3,500 for employer and employee. This means you will incur a $7,000 extra cost when you pay yourself a salary (employee and employer portion). The corporation must submit a T4 return (information return) at the end of the year as per CRA's requirements. If you continue to contribute to CPP, when you reach retirement age, you can be eligible to receive your CPP. The amount of CPP you receive when you retire will be based on the amount of CPP you have contributed.

• Salary can give you RRSP contribution room

Although the costs seem to be higher with salary, there are other benefits from paying a salary, such as RRSP contribution. Canadians can only make RRSP Contributions up to the RRSP contribution limit. The RRSP contribution limit is calculated as a percentage based on earned income. Salary is considered earned income. If you want to save money in your RRSP account, you must pay yourself a salary.

• You are entitled to an additional employment amount (as a personal tax credit) if you are paid a salary

You get another $1,287 employment amount as a non-refundable personal tax credit when you earn a salary. Calculated on the base personal tax rate, this equals $1,287 x 15% = $193 (in 2022) non-refundable tax credit. Unfortunately, this isn't available when you earn dividend income. Self-employed individuals are not eligible to claim this amount, unfortunately.

Dividend Compensation

• Dividends are not tax deductible for the corporation

A dividend is not a deductible expense for income tax purposes. It's important to note that dividends are paid out of the corporation's retained earnings which have already been subject to corporate income tax.

• Eligible vs. Ineligible Dividends

Canadian corporations may pay both eligible and non-eligible dividends to their shareholders. Non Eligible dividends will generally come from CCPCs subject to the small business tax rate. Ineligible dividends are taxed at a higher rate than eligible dividends at the personal level, as they receive the preferred tax rate at the corporate level. Canadian Corporations, or CCPCs, subject to the general corporate rate, will lead to Eligible dividends. Eligible dividends are taxed lower than ineligible dividends at the personal level. This is all part of the integration process.

Other considerations

When Applying for a Mortgage

When you are interested in getting a mortgage at the bank, a salary is likely preferred due to the steady, predictable income of a salary.

RRSP Contribution Room

The maximum RRSP contribution room is as follows:

A) the lesser of 18% of your "earned income" and

B) a maximum threshold.

The contribution room is maxed out at the maximum threshold, which also needs to be considered.

Summary

Salary vs. dividend remuneration decisions should depend on your and your corporation's financial situation. It is essential to consider the tax and non-tax factors when selecting the type of compensation that you choose. Furthermore, your decision on how to pay yourself may change over time. It's crucial that you discuss your case with a professional accountant and understand the various dynamics before deciding. This is not a one- and done exercise. Compensation should be reviewed every couple of years to ensure the plan still fits your personal and business goals.

The content of this blog is intended to provide a general guide to the subject matter. Professional advice should be sought about your specific circumstances.

By: Kamal Gawri, CPA, CA