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Salary or Dividends?

As an owner of an incorporated company, there are several decisions that need to be made which can impact your financial situation in the short and long term. One of the more common questions asked is how to draw out money from the corporation; salary, dividends or some combination? There are many factors to consider and there is no one answer that fits everyone.

Salary is an expense to the corporation and income to the individual. This expense is deductible to the corporation resulting in a reduction to the corporate tax expense. Personally, however, you are fully taxable on the salary earned. For example, if your corporation earns $100,000 profit before corporate income tax and you pay yourself $100,000 salary, the result will be no taxable income in the corporation. When it is time to pay personal taxes, you are paying at the normal personal tax rates instead of the preferred dividend tax rates.

Dividends are payments to shareholders from funds that have already been taxed at the corporate level. If in the same example, your corporation earns $100,000 profit before tax and you pay yourself in dividends rather than salary, the corporate after-tax income comes out to $84,500 assuming a 15.5% corporate tax rate. This amount can be paid out to the shareholder as a dividend. Because you have been taxed once already, the tax you pay on your personal tax return for dividend income is lower than the personal tax you pay on salary. Dividends are not deductible to the corporation; they are distributions of after-tax profits.

The goal of the income tax act is to have perfect integration; that is to make the difference between paying salary vs dividends minimal. Because there are so many factors involved, calculations and considerations need to be made to ensure the optimal strategy is undertaken.

Salary

Pros Cons
  • Salary expense is a deduction to the corporation resulting in less tax paid by the corporation
  • Earning a salary creates RRSP room and makes it possible to deduct child care expenses unlike dividends
  • Salary is fully taxable with no preferred rates
  • Canada Pension Plan (CPP) premiums are required to be deducted from your salary for most individuals and the corporation must match this amount which lowers what you receive
  • Payroll administration can be time consuming and may need to be done monthly

Dividends

Pros Cons
  • Dividends result in preferred personal tax rates
  • The corporation and the individual both avoid paying CPP
  • Little administration is required
  • The corporation does not get a deduction for paying dividends and therefore would pay corporate tax on the amount distributed
  • Dividends are not considered earned income which is the basis for creating RRSP room and deducting child care expenses

Salary or Dividend?

The following two examples assume 100% of the pre-tax profits are paid out as salary or dividends:

Salary ($) Dividends ($)
Pre-tax Profit of $100,000 100,000.00 100,000.00
Personal tax paid (includes CPP employee and employer for salary) (30,264.26) (11,592.31)
Corporate tax paid (dividends only) - (15,500.00)
Total taxes paid (Corp & Personal tax, CPP employer/employee) (30,264.26) (27,092.31)
Total tax as a % of corporate pre-tax earnings 30.26% 27.09%
After-tax cash flow to the shareholder 69,735.74 72,907.69
Salary ($) Dividends ($)
Pre-tax Profit of $750,000 750,000.00 750,000.00
Personal tax paid (includes CPP employee and employer for salary) (348,467.00) (205,791.00)
Corporate tax paid (dividends only) - (143,750.00)
Total taxes paid (Corp & Personal tax, CPP employer/employee) (348,467.00) (349,541.00)
Total tax as a % of corporate pre-tax earnings 46.46% 46.61%
After-tax cash flow to the shareholder 401,533.00 400,459.00

The following example illustrates the taxes paid if the corporation earns $750K profit and a mix of salary and dividends are paid out to the shareholder. This scenario provides slightly more savings than either paying only salary or dividends as shown above.

$250K Salary & $500K Dividend
Pre-tax Profit of $750,000 – Bonus down to $500K with balance paid as dividends 750,000.00
Personal tax paid (includes CPP employee and employer for salary) (270,390.06)
Corporate tax paid (77,500.00)
Total taxes paid (Corp & Personal tax, CPP employer/employee) (347,890.06)
Total tax as a % of corporate pre-tax earnings 46.39%
After-tax cash flow to the shareholder 402,109.94

Notes:

  • All figures are based on Ontario tax rates.
  • For simplicity, it is assumed that all profits are fully paid out as either dividends or salary. Combinations of the two and/or retaining profits in the corporation can result in more advantageous situations.
  • Although in the first scenario, salary provides lower after-tax cash flow, nearly 5K is contributed to CPP which can provide retirement benefits. When accounting for the benefits of CPP, salary may be considered more desirable.

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