Salary or dividends: How to pay yourself from a corporation in Canada
Posted on: December 21, 2023
It may seem like a simple or even silly question, but it’s one of the first that a new corporate business owner will ask (and probably should ask).
How Do I Pay Myself from a Corporation?
This question is extremely important. You did after all go into business so that you can make money… for yourself…
Simply put, you have 2 options: Salary or dividends.
In this article we will discuss both options, how they’re taxed, and what scenarios make each option preferable to the other.
Yes, you can be an employee of your own company!
From an income tax perspective, the corporation will receive a tax deduction for the salaries/wages you pay yourself. This is because corporations are taxed on net income (net income is your revenue minus all your expenses) and salaries/wages are an expense to the corporation.
But you will have to remember that as a shareholder, you are also the “employer”, and have certain obligations when paying your employees (including yourself). You are required to withhold the employee’s portion of CPP and income tax (but not EI because shareholders are exempt) from your pay cheque and pay these amounts along with the employer portion of CPP, usually by the 15th of the following month that you paid yourself. Failure to make these “payroll remittances” (as they are called) will result in hefty penalties, so it is critical that you are disciplined and organized with your approach.
Saving for Retirement
Paying yourself as an “employee” allows you to grow contribution room to your Registered Retirement Savings Plan (or RRSP), whereas dividends do not. If you’re not familiar with RRSPs, they are a deduction on your personal tax return, or in other words, any amounts contributed to your RRSP are not taxed until you withdraw from the RRSP. This can be an extremely effective mechanism to save for your retirement because you have more funds available to invest (because you do not have to pay tax on those funds) and they are likely to be taxed in a lower bracket when you withdraw the funds during your retirement.
You also are contributing to the Canada Pension Plan, which will allow you to receive CCP payments when you are 60-70 years old. The more you contribute to CCP, the higher your benefit will be.
As a shareholder of a corporation, you are entitled to its profits through dividend payments. This is essentially just a return on your investment.
It is important to note that dividends are not an “expense” to the corporation. In other words, they do not provide your corporation with a tax deduction. This means that you will pay corporate taxes on any amounts that you pay as a dividend in the same way you would pay corporate taxes on those amounts if you did not pay a dividend. You also pay personal tax on the dividend.
But isn’t that double tax?
It’s not, because (in simplified terms) you will receive a personal tax credit for any corporate tax that has already been paid.
In the end, you’ll pay very close to the same amount overall in income taxes between both options. You just have to be sure to factor in personal and corporate tax.
Much easier, but with a catch!
From an administrative perspective, dividends are far simpler: there are no requirements to pay remittances. But there’s a catch! Because you are not setting money aside for taxes, you can be stuck with a heavy tax bill: both in your corporation and personally. Bottom line: don’t just transfer all your corporation’s money to your personal account for spending. Have a plan!
In limited situations, dividends can allow you to income split with your spouse, even if the dividend represents an amount greater than the value of their contributions. This is an extremely effective way to reduce your overall tax burden. The rules around income splitting are complex, so don’t assume this is an option without consulting a tax professional.
Saving for Retirement
No, you don’t get RRSP room, or CPP benefits when you pay yourself exclusively in dividends. But, don’t be discouraged. If your corporation makes more than you need personally, you can always retain your savings in your corporation to grow investments for retirement (note, this should be done strategically so as not to impact your small business tax rates). But, when done properly, this can be a very effective strategy. Think of it this way: small businesses pay 11% tax on active business in Alberta (in 2023). This means that you have 89% of these earnings available to reinvest in your corporation. But, if you paid this to yourself in wages or dividends and invested the amounts personally (not through an RRSP), you would pay 25-48% tax (you would only have 52-75% of those funds available to invest). When you start investing within your corporation, you will likely want at least some amount of dividends so you are not paying high rate tax (the mechanisms here are complex, but that’s what we’re here to help you with! 🙂).
Should you pay yourself a salary or a dividend? Well, it depends.
To optimize your strategy we like to gain an understanding of your situation. Here are some of the factors we look at:
- Your plans for retirement
- Your personal spending and net income levels in the corporation
- The nature of your business and availability of income splitting
- The amount and type of investments in your corporation
Let’s summarize everything discussed in this article in a chart:
|✓ Taxed personally
|✓ Taxed personally and in corporation (personal tax credit available to offset corporate taxes paid)
|✓ None Required
|✓ Increases RRSP contribution room and CPP Benefit entitlements
|X No RRSP or CPP benefits
|X More complex
|✓ Less complex
|✓ Limited income splitting available
|✓ Complete income splitting available in limited circumstances