We work with business owners from across Canada and we are often asked about the difference between salary and dividends. If you own a business through a corporation, you have the ability to pay yourself a salary or dividends or a combination of both.
This article will look at the difference between salary and dividends and the main advantages and disadvantages of each. We will also see some common scenarios for when a business owner may choose one method over the other.
If you are paying yourself a salary or wage (same thing), the payments become an expense of the corporation and then employment income for you personally - you’ll get a T4. The expense reduces the corporation’s taxable income which reduces corporate taxes owing.
To pay yourself a wage, the corporation will need to register a payroll account with CRA. Each time you are paid, the corporation will need to withhold source deductions (CPP and Income Tax) from your pay. These source deductions are then remitted to the Receiver General (CRA) on a regular basis. In addition, each year the corporation must prepare and file T4s for any employees that earned wages.
We wrote all about registering for a payroll account and remitting source deductions here.
Paying yourself a wage can be a way for you to earn a steady and predictable personal income. Some key advantages of using this method include:
Dividends are payments to shareholders of a corporation that are paid from the after tax earnings 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 (more on tax differences below).
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 in one or many transactions. Each year, the corporation must prepare and file T5s for any shareholders who received dividends.
The tricky thing with dividends is that they are issued and paid based on share ownership. For example, if Pied Piper Ltd. wants to issue $100,000 in dividends to the owners of its Class A common shares, it must do so based on percentage of ownership. So, if Dinesh owns 30% of Pied Piper’s class A shares and Richard owns the other 70%, then Dinesh would receive $30,000 and Richard would receive $70,000. This can make it difficult to allocate different amounts of income to multiple shareholders if 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:
If you issue dividends, you will need to issue T5s and prepare corporate documents called dividend resolutions.
For a slick way to organize your corporate documents like dividend resolutions, check out Ownr. Our affiliate link gives you 20% off the cost of their managed corporation plans.
Ownr is a handy way of keeping your corporate documents organized without having to pay high rates of a lawyer.
(Spoiler - the answer is "it depends")
Ok, so the most common question we get about salary vs. dividends is “which method allows me to pay less tax?”. This is an important question, but changes to legislation that took effect at the beginning of 2018 have made it more difficult to reduce taxes by choosing one method or the other.
I’ve listed this question down here instead of at the top because I think it is more important to first understand and consider the issues listed above before comparing various wage and dividend models for tax savings. Often, the results of calculations show fairly minimal tax savings one way or another, and there is a reason for that.
There is a tax concept called integration that legislation aims to implement. The idea is that there should be little to no difference in the overall income tax paid (personal tax + corporate tax) when comparing dividend payments and wage payments of the same amount. How this works:
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.
Learn more about the limitations of dividend sprinkling on our article about Tax on Split Income (TOSI).
Although there may not be as much in tax savings to be had as in the past, we can still do some simple calculations to help determine whether dividends or wages are more tax efficient.
The idea is to calculate the total taxes (corporate + personal) that would be paid if dividends were used and compare that with the total taxes that would be paid if wages were used. You can use a tool like the SimpleTax Calculator to calculate personal tax estimates, and you will also need your corporate tax rate to estimate corporate taxes. Or if that sounds like a pain, you can call up your accountant and they’ll be happy to run some calculations (we love that stuff).
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.
Interested in learning more about corporations in Canada?