Should you take Salary or Dividend?

Executive Summary

Whether to pay yourself a salary or a dividend is a decision that every business owner is going to have to make. How you take income from your company can affect both your retirement planning and your taxes. It may also impact whether you can get personal financing. While there is no one method that will work for everybody, there are some key considerations that could help you pick the method that is right for you.

What You Need to Know

It is important to understand that Canada’s tax system is based on the Theory of Integration. The theory states that regardless of whether you chose earned income or dividends, if the integration is perfect then it should be the same net income either way.  Of course, nothing is ever perfect, and it is worth running the numbers to see if your situation can offer you a benefit for using one method or the other.

Numbers aside, there are some key advantages and disadvantages to consider. Below are some key points to consider that will help you make the best decision for you:

Salary

One of the major benefits of taking a salary is that you have declared personal income.  Having this income will allow you to contribute to both an RRSP and to the CPP. A salary will also create a tax deduction for the corporation, which can help reduce any tax burdens the corporation may have.  On the downside, paying yourself a salary means that 100% of the income is taxable.

If the business owner is considering getting personal financing, know that salary income is often considered more stable and predictable than dividend income which banks feel is a consistent cash flow that banks find reassuring. Salary income is also easily verifiable through pay stubs and employment records, making it a straightforward factor for banks to assess.

Dividends

The biggest appeal of paying dividends is that they are taxed at a lower rate than earned income.  Dividends are taxed inside the corporation, allowing you to be paid in after-tax dollars. Dividends qualify for a gross-up percentage that reduces the amount of tax you pay when you receive them from the corporation. A negative to taking dividends is without paying yourself a salary, and therefore having an earned income, you do not qualify to contribute to the CPP or to an RRSP. This can be an issue for some business owners when it comes to retirement planning.

Also considering personal financing, dividend income can be variable and depends on the profitability of the business. Banks may view this variability as a risk. Unlike salary income, verifying dividend income may be more complex, requiring documentation from the business, such as financial statements.

The Bottom Line

While there is no right or wrong way to pay yourself from your corporation, how you do so could have an impact on your retirement, ability to get personal financing, and tax planning.  A financial planner, accountant, or tax specialist can give you some guidance and advice that is specific to your situation, making it easier to make the final decision.