Salary vs. dividend: The best way to pay yourself
In this edition of The Bright Side, we focus on a particularly important topic for small business owners – how to best compensate yourself for the work you do.
Essentially, if you’re operating your business through a corporation, you have the option of paying yourself via salary, dividend or some combination. Each method has its pros and cons, including (yep, you guessed it) from a tax perspective. So, without further ado, let’s get down to the business of paying yourself.
Salary
Your corporation is a separate legal entity from you individually, which means you can choose to draw a regular salary for the services you perform for the corporation.
With a salary, income tax is immediately withheld on each pay period, resulting in lower taxes when tax time comes around. A salary also generates valuable RRSP room (dividends do not because they are considered “earned income”).
By drawing a salary, the corporation is required to deduct Canada Pension Plan (CPP) contributions from each payment, enabling you to earn a government pension when you retire.
Dividend
A dividend is when the corporation distributes some of its remaining after‑tax earnings to its shareholders. Generally, this option is more flexible and economical as your corporation does not need to remit any CPP deductions or taxes on dividends at the source.
As there is no need to make payroll remittances from the corporation, a dividend can be paid out from the corporation anytime. Likewise, you won’t need to register for payroll. You simply transfer funds from the corporation’s account to your personal account at your discretion.
A quick comparison
Trying to weigh all the pros and cons between salary and dividend compensation options can be confusing. This side‑by‑side table comparison can help illustrate the key differences and, ultimately, which approach may be best for you.
|
Salary |
Dividends |
|
Must remit CPP |
No CPP to remit |
|
Generates RRSP room |
Does not generate RRSP room |
|
Corporation can deduct salaries from its taxable income |
Dividends are not deductible for the corporation |
|
Lower corporate tax |
Higher corporate tax |
|
Higher personal tax |
Lower personal tax |
|
Need to withhold and remit personal income tax at source |
Pay personal income tax on dividends by instalments or with your tax return |
|
Requires T4 preparation |
Requires T5 preparation |
Reference: LRK Tax LLP. (2022, February 19). Salary Vs. Dividends – LRK Tax LLP. https://lrktax.ca/resource/salary‑vs‑dividends/
Which way to pay?
It really depends on your unique circumstances. If you’re planning to apply for a home mortgage or loan, paying yourself a steady salary is the way to go. If you want to keep more cash in your corporation, paying yourself via dividends is the better option.
We’ve only scratched the surface here, as there are a number of other factors and nuances that may come into play. Your accountant can help with tax planning to determine which option, or combination of options, would be most advantageous for both your business and personal finances.
It all comes down to selecting the right compensation strategy that allows you to build your personal wealth and reap the rewards of all your hard work, while ensuring your company remains fiscally sound.
Manager, Client Advisory at Baker Tilly Catalyst, Shannon McIntosh has overcome anxiety, insecurity and depression to emerge as a voice of empowerment, helping clients and colleagues exceed expectations and break new ground. In The Bright Side, she taps into her specialized experience working with non‑profit businesses and her passion for helping organizations that support the community to offer enlightening tax, financial and business guidance to help replace self‑doubt with self‑belief.
Shannon McIntosh
Shannon McIntosh