Salary vs. Dividends: Optimal Compensation Strategies For Business Owners
It’s been said that Canadians only pay taxes on two things-everything we do and everything we buy. Minimizing your taxes is a great way to maximize your money. Most people have no choice but to take their income as salary, but what’s the best way to pay yourself as a business owner? Business owners often have a choice of compensation between salary and dividends.
When deciding between salary and dividends, Ottawa business owners must consider how each can affect them now and in the future. Canadians pay a high tax rate, and any way to reduce it leaves more money in your pocket. Regarding tax strategies for business owners, Ontario residents sometimes choose dividends over salary. However, both types of compensation have advantages and disadvantages.
Should I take dividends or salary?
Your corporation can pay you a salary, pay you dividends instead of a salary, or pay you using a combination of both. Your priorities should determine which method works best for your circumstances.
Before you decide on how you want to take your compensation, it’s essential to understand the implications of each. Some business owners prefer to pay the least tax possible and take dividend income instead of a salary. Others realize they could be missing the benefits a salary offers.
Salary vs. dividends
A salary is an amount you have agreed to take as compensation for your work that the business pays you. The company pays you a set amount on an agreed-upon pay schedule. The business pays the wages it owes you and any deductions, such as its portion of the Canada Pension Plan (CPP) and Employment Insurance (EI).
Each province may have additional costs, such as WSIB in Ontario. The corporation deducts your salary as a business expense. The business deducts your share of income taxes, the Canada Pension Plan, and Employment Insurance before you receive your paycheque.
On the other hand, dividends are paid out of the business’ after-tax profits, which is the income left over after all taxes have been deducted. After-tax profits are the earnings that remain once all taxes, including corporate income tax, have been paid. The company receives no tax deduction for paying dividends. Income tax, EI, and CPP are not withheld from your dividend payment. The business does not make contributions to CPP and EI on your behalf.
Pros and cons of salary vs. dividends
Each type of compensation has its merits. The best way to pay yourself as a business owner depends on your long-term goals. The main differences between these tax strategies for businesses in Ontario are:
| Salary | Dividends |
| Salaries are a tax deduction for the business | Dividends are paid with after-tax profits |
| Regular payment schedule | Payments may come at irregular intervals |
| Income tax is deducted at source, but you may have to pay more, or you could get a refund at tax time | You must pay income tax by April 30, or you can pay it quarterly |
| You and the business pay CPP contributions | No CPP contributions |
| Builds RRSP contribution room | Does not build RRSP contribution room |
| Easier to get a loan or mortgage since lenders prefer to see a steady, stable income | May be more challenging to qualify for a loan or mortgage |
| Allows for income-tested government benefits like the child tax credit | May not be eligible for income-tested government benefits |
| Some tax credits and deductions, like childcare expenses, only apply to income from salary | Ineligible for some tax credits and deductions |
| Salaries generally result in higher income taxes | Dividends taxes at a more favourable rate, leaving more money in your pocket |
How to decide?
Your choice of compensation depends on your current circumstances and what you want to achieve financially. Some questions to ask yourself are:
- Do I plan to get a mortgage or loan soon? If the answer is “yes,” a salary might be better for you.
- Is paying into the CPP important, or would I rather save the money? If collecting CPP isn’t part of your financial plan, you’ll save the contributions by opting for dividend income.
- Do I want to use my RRSP to save for retirement and use the contributions as tax deductions? A salary will build RRSP contribution room, but dividend income won’t.
- Do I want to qualify for income-tested tax benefits like the Canada Child Benefit? If these benefits don’t apply to you, you could choose dividend income instead of a salary.
- Are tax credits and deductions based on salary important to me? If they are, a salary may be better than dividend income.
If you choose a salary, personal tax credits, deductions, RRSP contributions, and TFSAs can provide some tax relief, but you might still save more on taxes by claiming your compensation as dividend income.
An accountant or financial advisor can provide valuable insights into your and your business’s financial picture, guiding you to the best decision for your circumstances. Their expertise can help you navigate the complex tax implications of your compensation strategy, providing you with the support and guidance you need.
How a Financial Advisor Can Help
One critical aspect of choosing a salary or dividends is how you plan to fund your retirement. Knowing whether the CPP and an RRSP are beneficial for you will help you select the proper payment structure.
To make the best decisions regarding compensation strategies, such as salary or dividends, Ottawa business owners can consult a financial advisor. At MDL Financial, we’ve been helping business owners design their financial futures for over thirty years. We’d love to help you decide how your business should pay you and plan for a successful future. Contact us online or call us at 613-416-9649 to learn more about how we can help.
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