If you’re a business owner who also works in the business, you will likely want to be compensated for the time and energy building and working in the business.
Business owners who are also working in the business can take a salary or a dividend or a hybrid form of compensation for their work.
There are a lot of factors to consider when making this decision, as it can affect the finances of the business and your own personal finances.
It is important to note that tax laws in Canada aim to create a system where there would be no difference in taxes owed whether the owner is taking a salary or dividend. However, there might be a difference in practice, because this is such a complex topic. There are also non-monetary aspects to consider when making this decision.
A salary is a recurring payment paid to compensate the owner for the time and energy spent in the business.
The owner records his salary as an expense to the company and issues a T4 tax slip for tax purposes. Thus, the salary will be a source of personal income for the business owner.
Since the owner’s salary is a deduction against income, the business will report a lower net income.
Administrative tasks are also associated with paying a salary for any employee, even if the employee is the owner.
The business will have to register a payroll account with the CRA. Then, as with other employees, the company will have to withhold and remit payroll taxes to the CRA and contributions to the CPP for each salary payment.
- Lower corporate income tax – Salaries are an expense, lowering the company’s net income and taxable income. The payment is taxed at the hands of the owner on their tax return. The business’s taxable income will be lower if the owner is paid a salary.
- More administrative work – Registering a payroll account, issuing a T4 and making remittances to the CRA can be a burden for small businesses, adding more work to their plate.
- Recurring expense – salaries are typically regular payments. This can be an added source of cash outflow for the business.
For a business owner, a salary can have an impact on their financial situation. The business owner is now considered an employee of the business. Their tax situation would be as if they held a job, like any other employee.
For business owners, this can provide certainty and stability in their finances.
- Easier to save for retirement – Salary is considered earned income, making it easier for the business owner to save through involuntary contributions to the CPP.
- RRSP Contributions – Earned income, such as a salary, builds room in their RRSP. These RRSP contributions can have a taxable benefit as well.
- Fewer surprise tax bills – Payroll taxes are deducted and remitted to the CRA before the salary is paid. This means that the business owner will likely have no surprise taxes due at the end of the year if they receive a salary.
- Mortgage and Personal Loans – If the business owner is looking to buy a house and apply for bank loans and mortgages, banks may view a salary more favourably as it is a record of consistent income.
A dividend is a payment made from the company after you have deducted taxes. Dividends are paid to investors and owners of the company from the profit the company makes.
Dividend payments are made with after-tax dollars. The company will have to include the amount in its net income and pay taxes based on this amount. The dividend payment is made after taxes are considered.
The corporation would issue a T5 slip to the business owner with the amounts paid.
- Simple payment process – The payment process is simple, no need to register for payroll, nor are there any withholding or remittances made to the CRA.
- Non-recurring payment – Dividend payments can be arbitrary, which can help the business in managing cash flow.
- Higher corporate income tax – Dividends are not an expense to the company and cannot be deducted against net income or taxable income. As a result, the business’s taxable income will be higher if the owner is paid through dividends.
- Tax Bill – While the company pays dividends with after-tax dollars, the owner has to include the dividends as income. The owner is required to pay taxes on this income. It would be prudent to set aside some money to make this payment when taxes are due.
- Need an individual retirement savings plan – CPP contributions and the RRSP are unavailable to business owners who take dividends. If retirement is a personal consideration, the business owner will need to make their retirement plan rather than rely on government programs.
- Hard to show earned income – If the business owner is looking to take out a personal loan or mortgage, dividends may not be enough proof of a bank’s personal income.
There is, unfortunately, no clear-cut answer for a business owner debating between salary and dividend payments. While a salary may work best for one business owner, a dividend may be better for another. And for yet others, the correct answer may be a hybrid solution – part salary, part dividend.
This dilemma is quite complex, as it can impact both a business’s finances and your personal finances.
It is vital to consider both the financial and non-monetary issues when picking the best option for your situation.
Contact Glenn Graydon Wright LLP in Oakville for guidance on what factors to consider when choosing salary or a dividend compensation for business owners.
Please seek advice from our tax professionals, accountants, or other financial professionals to ensure that you are well-informed about what is right for you and your business. The team at Glenn Graydon Wright LLP can review your options with you, as well as the benefits and liabilities of each as they specifically apply to you. Contact us by phone at 905-845-6633 or reach out online.