Salary Vs Dividend : Which is best for a small business owner ?
Just before the start of every tax season, one question always comes up in the minds of every small business owner - Do I pay myself through a dividend or a salary ? Read more to find out all the facts
TAX SMALL BUSINESS
Just before the start of every tax season, one question always comes up in the minds of every small business owner - Do I pay myself through a dividend or a salary ? Which one has a lower tax implication ? How am I best availing the lower tax rate for my small business
Before answering this question, it is worth exploring the small business tax rate in Canada. CRA charges a much lower 15% corporate tax rate to small businesses. The aim of this policy is to encourage public investment in small businesses in Canada. While the reduced tax rate is very much beneficial if you are reinvesting your profits in your business, the benefits quickly evaporate when it comes to transferring the profit from your small business corporation to yourself. Through a principle known as integration, the CRA charges a higher tax rate on dividends distributed out of an eligible small business corporation. In effect, the income taxes that you will pay on your personal income from your small business dividends will be much higher than you would pay on dividends from a public company. The idea behind integration is that an individual should be indifferent between dividends and salary for transferring the profits from a tax point of view.
Now that we have established that there is little difference in tax rate, what is the argument for taking a dividend from your small corporation vs taking a salary ?
It is true that paying yourselves a salary has many distinct advantages. This includes participation in retirement programs like Canada Pension Plan (CPP) which has historically yielded above market returns. Also, a salary increases your RRSP contribution limit, thereby helping you lower your payable tax in the future while saving for your retirement. So in a nutshell, taking a salary from your business is more advantageous in majority of cases as this will help you participate in a variety of tax sheltering programs like RRSP and CPP, and there is almost no difference in the tax rate for a salary vs a dividend.
That is not to say that paying yourselves a dividend is not a good option. Paying yourself a dividend can be tax advantageous in certain cases, like when your corporation has prior year losses to claim. Since salary is paid from before tax income, there is no option to offset the prior year losses since the salary removed that profit from the business with tax, while the profit would not have been taxed anyways due to the prior year losses.
Contact us today to know which tax strategy is best for your particular case.
