As the owner-manager of an incorporated company, you're required to
make many decisions. Since you're in charge, it's up to you to
decide how you'll be compensated. Should you choose a salary or
dividends? Each method has its advantages, depending on your
situation. What do you need to know to make an informed decision?
True. In most cases, it's more beneficial to pay yourself a salary and pay the taxes on it. Why? Because your salary is deducted from the company's revenues. Individuals usually pay less in taxes than a company would on the same amount. The higher your company's income tax rate, the better it is to pay yourself a salary.
A salary is better for distributing the revenue generated by the company when:
Another benefit of having a salary: You can contribute to an RRSP to reduce your taxable income.
Note that the value of this benefit varies according to your age. The younger you are, the longer your contributions will continue to grow tax-sheltered.
When you receive a salary instead of dividends, you contribute to government pension plans. The amount deducted from your pay cheque eventually comes back to you as indexed retirement income (pension).
It's more beneficial if you haven't maximized your contributions when:
It's less beneficial when:
There are federal and provincial laws on taxing income. Does your company have a lot of investment income? Have you chosen to invest the company's earnings rather than putting them back into the company? If so, the company's business limit will be lower. This results in a smaller proportion of the company's income being taxed at the lowest tax rate.
Consequence: It impacts the type of dividend your company can pay.
In Quebec, the tax rate changes according to the combined hours worked by all the employees in a company.
Consequence: A company that doesn't have many employees won't benefit from the lower tax rate of the first income tax bracket. It will affect the type of dividend that the company can pay.
Important: Remember that there are many factors that can influence your decision, and the related laws and regulations are complex. We therefore recommend that you call on tax and accounting specialists to help you decide whether paying yourself a salary or dividends is the best way to go.
True. In some cases, you may even end up paying less income tax. It depends on:
To choose the best option, you must:
Generally, dividends are better for distributing the revenue a company generates in the following situations:
Expert advice: To reduce the taxes you'll pay when you're retired, it's a good idea to have a plan to draw down investments in your holding company.
Dividends are a company's earnings that are distributed to shareholders.
Generally, here's how dividends work:
Are you the sole shareholder running your company? If so, that makes you the Board of Directors, so it's up to you to decide. If you choose to pay out dividends, you'll be the sole recipient. You're also responsible for deciding the payment terms.
Expert advice: All transactions, like declaring dividends, must be recorded in your books. This will give you a complete picture of your finances, maximize your chances for success, and make it easier to get financing, not to mention all the work you'll be spared come tax time.
To fully understand the different types of dividends, you need to start with a key tax principle: Integration. The purpose of integration is to have all income taxed at similar rates. No matter how the money ends up in your pocket, the tax authorities will eventually get their hands on approximately the same proportion of it.
For this reason, there are several types of dividends. The more they've been taxed as company income, the less they'll be taxed in your hands. And vice-versa.
So, high rate + low rate, or low rate + high rate
Whatever the scenario, the result is pretty much the same where taxes are concerned.
Here's how it translates for the main types of dividends:
This is a classic example of low rate + high rate. Before being distributed in the form of non-eligible dividends, the company's revenue is taxed at a lower rate.
Why a lower rate? Because the dividend is paid from money that the company generated, which is below the business limit. It varies depending on several factors, but the business limit is generally around $500,000.
To compensate for the lower initial tax rate, these dividends are identified as non-eligible or regular dividends. Once they're paid to shareholders, they're taxed at a higher rate.
Inversely, eligible dividends paid to shareholders have a lower tax rate for the simple reason that they're paid from company revenue that has already been taxed at a higher rate. High rate, then low rate.
Why? Before being paid out as eligible dividends, the revenue generated by the company exceeded the business limit threshold. This is all tracked in the general rate income pool (GRIP). A GRIP is a tax account that doesn't actually contain money, but it serves to designate the amounts that can be paid as eligible dividends.
Capital dividends are tax free for the shareholders who receive them, but they don't just magically drop from the sky. They come from company-generated revenue that is not taxable.
Unlike the first two types of dividends we've looked at, it's neither high rate + low rate, nor low rate + high rate. There simply isn't any tax to pay.
How many of these "super" dividends can be paid? To find out, you need to check the balance of a tax account called the capital dividend account (CDA). The higher the balance, the more tax-free dividends can be paid to shareholders.
Pro tip: As with the GRIP, your company accountant should know your CDA balance, even if it doesn't appear on the balance sheet.
Instead of cash, an eligible dividend, non-eligible dividend, or tax-free capital dividend can also be paid in the form of shares or property owned by the company. These types of dividends are much less common.
Bear in mind
Are you a business owner? You don't necessarily have to be compensated for your work. If you're able to support yourself without taking money out of the company, it can be a good idea to keep it in the company. This way, you avoid paying taxes on income you don't really need. Of course, not everyone is in this position.
You could also choose to pay yourself and benefit from registered investment plans like RESPs, RRSPs, and TFSAs. Here's why:
RESP (Registered Education Savings Plan): Save in a tax-sheltered environment and receive grants for your children's post-secondary education
RRSP (Registered Retirement Savings Plan): Accumulate retirement savings that are tax sheltered until they are withdrawn
TFSA (Tax-Free Savings Account): Save and avoid paying taxes on the increase in value (e.g., interest)
There are several ways to pay yourself, depending on your company's situation, your needs, and your resources. Contact us if you'd like help maximizing your compensation and finding the winning combination for you. Consult our specialists who can help you choose between dividends and a salary. We’re here to answer your questions.
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