To start, as a business owner, you MUST pay yourself. You cannot wait until the end of the year to look after paying yourself; instead, you must pay yourself regularly. You are managing the business, right? What happens if you get hit by a bus? You’ll have to hire someone to do what you did and you’ll have to pay them…..so you should pay yourself. Now how do you do that?

Do you take a salary or a dividend?

There is no right or wrong answer here. It all depends on this and that. And I cannot stress enough that you must pay attention to the advice of your accountant. But here is a good summary.

If your business is not incorporated or otherwise you set up your business as a Sole Proprietor:

You must declare all your business income as personal income; so you cannot pay yourself any other way. You are not required to pay Employment Insurance (that is an option now) but you must pay CPP premiums and of course income tax.

If your business is incorporated:

If you take a salary then like any other employee you hire, you are required to pay CPP, and income tax.

The salary is considered to be income and is taxable at the income rate that you fall under, unlike dividends, which are taxed at a lower rate.

There are benefits to paying you a salary:

If you need a line of credit or a mortgage on your home, then you should pay yourself a salary. The bank needs proof of your earnings.
It increases the limit on your Registered Retirements Savings Plan contributions every year – dividends do not.
It gives you the eligibility to receive a pension because you are remitting payments to your CPP – dividends do not.
Salaries are tax deductible whereas dividends are not because they are paid after-tax dollars.
As well, you will be able to claim certain personal income tax deductions such as childcare expenses against your salaried income. Again, you cannot claim these expenses against dividend income.

There are also disadvantages to paying you a salary:

You have to remit tax deductions and both portions of CPP contributions to the CRA. This requires more administrative work and it does reduce your business cash flow.
If you are operating a business whose profits vary from year to year, paying yourself a salary can trigger you tax problems because you won’t be able to carry back a business loss in future years, as you could if you had paid yourself by dividends.

Dividends

There are advantages if the corporation pays you in dividends:

Dividends are taxed at a lower rate than salary, which can result in you paying less personal tax.
Not having to pay into the Canada Pension Plan can save you money.
Paying yourself with dividends is comparatively simple. You write a cheque to yourself from your corporation at the end of the year.

There are also disadvantages:

Receiving dividends doesn’t allow you to contribute to an RRSP as you don’t have any income, and
Receiving dividends instead of salary can “kill” other possible personal income tax deductions for you, such as child care expense deductions.

What is the answer?

There is a small business deduction for corporations making $500,000 or less, so obviously, your profits will be taxed at a lower rate. (About 16% depending on which province you operate in). If your business makes over this limit, then it would make sense to pay yourself a salary to reduce your corporate income to $500,000.

It all depends on the following: