If you are own an incorporated business, you have at least three options of how to pay yourself: salary, dividends, or a combination of the two. Depending on your particular situation, each option comes with its own advantages and important considerations.
Paying yourself a business salary or wage, which are effectively the same thing, works the same for your as it would for any other employee in your business.
The salary paid must be reported as personal income, and as such you would pay your personal income tax rate on the salary.
Typically, this rate is higher than the equivalent corporate tax rate. A higher salary will also be taxed higher as a part of the salary may meet the threshold for a higher tax rate bracket.
You will also report the salary as an expense for your business, lowering your corporate taxable income.
To pay a salary to yourself or any employee, you must first register a payroll account with the Canada Revenue Agency (CRA) for your business.
After you register, you can start paying yourself a salary. For each payment, make sure to withhold CPP and Income Tax deductions from your pay. The corporation will also have to file and provide T4 sheets for any employees that were paid that year.
Dividend payments are considered investment income, much like dividends you would receive from holding certain stocks.
Since dividends are paid from your company's net income after taxes, they would not reduce your corporate owing like paying a salary would.
The CRA requires corporations to file T5 forms at the end of each year for every individual that received dividend payments from the corporation.
Aside from the T5 form (and recording the transaction in your books), paying dividends is as straightforward as transferring funds from your corporate accounts to your personal accounts.
The short answer is: it depends.
In terms of tax savings, dividends may be advantageous as corporate tax rates tend to be lower than personal income tax rates. However, unlike salaries, managing taxes for a corporation is a more involved process. If done incorrectly, you may run into surprise tax bills later on.
Dividends also offer more flexibility in planning for retirement savings, but this also comes with a risk - improper planning may lead to unexpected trouble later on.
In contrast, taxes on salaries are straightforward, ensuring there will be no surprises in tax season. A salary may also be important to show income if, for instance, you plan to buy a home and would like to qualify for a mortgage.
Whether you choose to pay yourself a salary, dividends, or a mix of the two, having a proper plan in place is essential. Taking advantage of technology to automate the process will also help you save time and ensure you did not miss any important details. Send us a message if you have any questions or would like help determining which approach is best for you and your business.
