When it comes to owning and operating a business, deciding how to pay yourself can be a tricky decision to make. If your business is a corporation, meaning that it is considered to be a legal entity separate from you as an owner, you have options!
You can pay yourself a salary, receive money via dividends, or draw from a mixture of both. While all options will require you to file a personal income tax return as well as a corporate tax return, knowing which option serves your needs best will help you come out on top during tax season.
Receiving a salary and/or dividends have their fair share of advantages and disadvantages. It’s important that you have a functional understanding of both in order to make the choice that is most beneficial to you and your company.
Simplifying Salaries
A salary is predetermined annual wage that you receive over the term of your employment. Each pay cheque will be exactly the same (excluding any bonuses) and that amount will not change unless the terms of your salary are altered or CRA updates their source remittance schedules (usually every January and July)
Receiving employment income in this form will help show that you earn a stable income which is beneficial when applying to banks for loans and/or mortgages. However, if you decide to pay yourself a salary from your company’s earnings, there are a few additional points that you need to be aware of.
The first is that you must register a payroll account with the Canada Revenue Agency (CRA). This means that for every payment you receive, you will need to withhold and remit income taxes. These usually have to be paid each month (the next one coming up on January 15th), on time, or the result will be monetary penalties.
You also have to make mandatory contributions to your Canada Pension Plan (CPP) if you receive a salary, keeping in mind that if your net income exceeds $3,500 annually as an owner you must double your CPP contribution. While this is a fair chunk of money upfront, it is a good option if you know that you will be relying on your CPP for retirement in the future.
In contrast, as a business owner, you do not need to make contributions to your employment insurance (EI). This will save you money upfront but it will make you ineligible to receive those benefits in the event that you need to terminate your own position.
Secondly, it’s important to know that these payments are considered to be a company expense and equate to employment income. This means that you will need to generate a T4 slip which reports your earnings over the course of the year, including any year-end bonuses or management fees – just as you would do for any employees.
One of the benefits of claiming a salary is that it reduces your company’s taxable income, therefor also curbing the amount of corporate tax owing come the tax deadline. As well, since your business salary will be counted as personal income, you may be able to qualify for income tax credits such as medical, parental, or low income.
On the flip side, you are subject to the personal income tax rate on your salary and it tends to be higher than the corporate tax rate… so knowing what it most beneficial to your personal situation is important.
Demystifying Dividends
Dividends are a type of investment income that come from receiving a return on your company shares. They are considered to be separate from personal income and are issued and paid based on your percentage of share ownership.
For example, if your company is looking to pay out $200,000 dollars in dividends based on share ownership, and you own 50% of the shares, then you would receive $100,000.
It’s most common for dividends to be paid out to company shareholders, in which case you would need to file individual T5s once a year for every individual who receives one – including yourself! You also likely receive a T5 from any investment accounts you hole, even if they are unrelated to your business. If you are the sole owner of your business, you are not required to register with the CRA or submit remittances. This eliminates the chance of late or missed payroll payments. You can simply declare a dividend and transfer cash from your company to your personal account.
In comparison to receiving a salary, dividends are not considered a company expense so it will not reduce your company’s taxable income. This being said, dividends are subject to a corporate tax rate which is generally lower than the personal tax rate that you would pay on a salary. Another point to consider is that dividends are often not as consistent of a payment as a salary, which may make it challenging to apply for loans and/or mortgages.
As well, dividends will not help you to build up contribution room in your RRSP or your CPP since forced contributions are not required. This means that you must actively plan for retirement and contribute to your own savings plan in order to have a comfortable nest-egg later on in life… so pre-planning is key!
What Should I Choose?
The honest answer? It depends.
The method of compensation that you choose is largely dependent on your financial goals and your specific business situation. The choice leans on both tax and non-tax factors that should be discussed with an experienced tax advisor to help determine which option is best for you and your company.
That’s where we come in. Taking the guesswork out of accounting and ensuring you succeed is our top priority, so book a free consultation with one of our trusted Chartered Professional Accountants today.
Let us help you get the answers you need.
IAPC Has You Covered
If you’d like to know more about our accounting services in Chestermere, book a free consultation with one of our trusted Chartered Professional Accountants today.
