Wages vs Dividends
Wages vs. Dividends
If you own an incorporated business, there are two primary ways to pay yourself:
- Salary, and/or
If you pay yourself salary, the amount is a deductible expense to your company and is taxable in your hands. You will be required to deduct income tax and CPP premiums from your salary.
Alternatively, you can have the income taxed in your corporation and then pay the after-tax earnings to yourself, as dividends, which is not deductible for the corporation. Dividends are payments made to company shareholders from the profits of the company. If the company has not made a profit over a given period then it cannot pay a dividend. With dividends, you would need to complete a T5 return: Return on Investment Income.
You’ll face tax on the dividends paid to you, but at a lower tax rate than salary.
Since, the corporation has already paid tax on the income when dividends are received, the amount is “grossed up” and then you are entitled to a dividend tax credit (to provide a tax credit for the approximate tax that was paid by the company).
Pros and Cons when considering Salary or Dividends:
- § Salary will count as earned income for pension contributions and dividends will not.
- § Help with financing purposes. If you are planning on applying for a line of credit or a mortgage, then paying yourself a salary will help you qualify.
- § Salaries paid by the company are an expense to the company and can reduce net income and corporate taxes payable.
- § Can be used only to pay employees of the company.
- You will be required to deduct income tax and CPP premiums from your salary.
- Have the burden to do payroll. (For example, manage payroll remittances to the Canada Revenue Agency, preparation of T4 slips, calculation of source deductions, etc.
- Can be paid to individuals who are not employees of the company (They must be shareholders).
- More tax efficient; dividends are taxed at a lower rate than salary.
- Dividends are administratively simple, although you will need to file a T5 with CRA by February 28 of the following year. Dividends also require a resolution by the Directors of the company.
- You can only pay dividends out of profits made by the company (If there is no balance in retained earnings, dividends can’t be paid out).
- Directly reduces the equity of the company. (For example, when a dividend of $100,000 is declared and paid, the corporation’s cash is reduced by $100,000 and its retained earnings is reduced by $100,000).
- Dividends are not an expense of the corporation and, therefore, dividends do not reduce the corporation’s net income or its taxable income.
- If you pay more in dividends, you can create tax problems later on and, if the company becomes insolvent, you may be liable to repay the dividends taken.