Should I pay myself a salary or a dividend?

Please note that none of this advice should be taken as a replacement to a thorough review with a certified professional. This blog is purely from my own personal experiences that I wish to share and your individual situation may be different. 

When I first started my business I had no idea I had a choice in how I paid myself. Afterall, I was an employee for quite a number of years in the beginning of my career, and quite frankly I never bothered about taxes. I mean there really was not much I could do about taxes-- they came off my pay and the only way I could lower the taxes I pay was contributing to my RRSP (Registered Retirement Savings Plan). That was really the extent of my knowledge-- And let's be honest, taxes are not the most fun of topics anyway.

However, after starting my own business, I realized there were numerous ways that I could potentially save on taxes that were not available to me previously as an employee. And after a lengthy consultation with my corporate tax accountant, I gained a much better understanding of the different ways I could be paid as a consultant of my own company and the direct correlation this had to the amount of taxes that I had to pay.

Now keep in mind, this is from a point of view of an incorporated business and if you want to learn more about how to incorporate your business or what are the benefits of incorporation, check out those two links first!

Today I will go through the differences of a salary versus a dividend and break it down with an example.

SALARY

Of course every one reading this should know what a salary is. But let us dive a little deeper. A salary is generally used as a form of compensation by many businesses to their employees. It allows for easy accounting, budgeting, and forecasting as the numbers are usually static from week to week. That is, for an employee to work 40 or 80 hours a week, the financials are usually the same. However as your own business, paying yourself a salary means your corporation has to withhold taxes (Employment Insurance and Canada Pension Plan) and on top of that, your personal income will be taxed the provincial, federal, Canada Pension Plan, and Employment Insurance amounts respectively.

The benefit is that your corporation is able to write off those amounts. As well, you as an employee of your company will have the benefit of a pension from the government upon retirement and Employment Insurance coverage in the event you are not able to work. Another not well known advantage is, your company will have to issue T4s to yourself as an employee. Therefore, your income is easily provable when it comes time to take out a loan or mortgage at any financial institution.

dividend

Now here is where things get interesting. As the majority shareholder and director of your company, you are able to, at your sole discretion, decide the amount and the frequency your company splits its profits with the shareholders (in this case, just you). You may have some experience with this if you have ever invested in stocks of another company. Periodically (commonly quarterly) the company will split profits with their shareholders (most of the time this is reinvested back into the company stock). But since that is your source of income in your case, the dividend will be transferred directly to your personal bank account.

As opposed to you just taking out money whenever you need, I would recommend that you come up with a schedule of payments (be it bi-weekly, weekly, monthly etc) with your tax adviser and stick to it. This will look a lot cleaner on the books and easier to reconcile for accounting purposes.

When you pay yourself a dividend, it is not subject to any Employment Insurance and Canada Pension Plan deductions. Taxes paid at the end of the year will also be at a lower rate compared to a salary of the same amount. Generally you do not remit taxes to the Canada Revenue Agency until the next year, so another advantage is you are actually able to do whatever you wish with those taxes, including doing short term investments with them; provided you can pay it back the following year. This can amount to $30 000 - $50 000 (including 13% HST) of the government's money that can you accure interest on. Crazy right?

The disadvantages however of paying yourself a dividend is that your business can not write off these amounts, and of course because you are not paying into the pension or EI, you will have to save for yourself in the case of retirement or any inability to work. Also if you were to apply for a loan, you may have a harder time proving income due to the fact that you are not receiving a salary. However, this does not mean you will not get approved. It is important to disclose your situation to your financial adviser and work with them to in providing documentation of business revenue as well (which is usually accepted at most institutions provided you have at least 2 years of corporate tax returns).

Okay great, so now that we know the difference and some pros and cons of both, let's look at a real life example with some numbers. With the theory of integration, both methods should come out the same, but depending on your situation this may not always be the case.

Assumptions

• Gross business revenue of $200 000 per year
• Your business operates in Ontario, Canada in 2018
• Salary of $40 000 
• Dividend payments of $40 000
• When being paid a salary, you did not contribute to your RRSP (which lowers the taxes you pay)

As you can see, in this example being paid a dividend you will come out slightly ahead, overall you save approximately $2 800 in combined business and personal income. However, from above, I have also made a few assumptions that can change the value of these figures.

This chart above shows your how your financials would look if you invested the full 18% into your RRSP, thus lowering your effective taxes paid. Do note that a dividend is not considered "income" for the purposes of an RRSP, therefore you do not get any contribution room for being paid dividends.

Firstly, I assumed that you would have contributed $0 to your RRSP. This really depends on your preference. If you wish to contribute, you can do so at up to 18% of your annual income (unused portions are carried over year to year and stack), which will actually lower the amount of taxes you have to pay, in this case a contribution of $7 200 to your RRSP (18% of $40 000) will lower your taxes by about $1 600. Thus, if you do that, going the dividend route only saves around $1 200 net in this case. It is to note however, going the dividend route you will have more flexibility to invest (TFSA, real estate etc) as you wish instead of locking into an RRSP which is usually kept for your retirement or in some cases your first home. As well, putting money into an RRSP does not mean you never pay taxes on those amounts as it is treated like income if you ever take them out. They are really meant to be used at retirement, which by then your annual income should be lower, thus you would pay less taxes then. Lastly, depending on how much you pay yourself will affect these figures as well. The more salary and/or dividends paid out, the more overall taxes you will pay.

conclusion

Generally as a rule of thumb, I would keep as much money inside the corporation as possible. Due to the fact that your business only pays 15% for all gross income under $500 000, it is hard to beat that. 

At the end of the day, there is no clear cut solution to this very question as each individual situation should be examined closely and my advice is consult with a tax accountant to find out if paying yourself a dividend, salary or even a bit of both will be most beneficial.

Hope this helps and happy savings!