Dividends or Salary, Which is Best for the Business Owner?

It’s a tough question that is often asked of small business owners, “Which is a better way to pay myself, a salary or dividends?” And it’s a valid question, since there are pluses and minuses to each of these. A dividend paid from the retained earning, which is the profits left in the company after all expenses and taxes are paid. For more on this, see the Wikipedia entry, which does a pretty good job of explaining them for the layperson. A salary is something that most people are familiar with and is considered an expense to a corporation. If you are a sole proprietor, then this whole question is irrelivent, since you are the company and any money made after expenses is taxed as if it were earned income. But which is better for the small corporate owner?

The dividend comes from money that is already taxed. For 2012, in Alberta, that means that there has already been a total of 14% taxes paid to the federal and provincial governments. Because of this the dividends are taxed at a lower rate than a salary would be. For example, if your only income was dividends and you earned $60,000, then you would have $5,034 in taxes payable. It seems paltry on $60,000. But remember that there has already been $9,767 in taxes paid to get that $60,000 – the corporation paid it. Therefore the actual earnings were $69,767 and the total taxes are going to be $14,801. Seems confusing? Well, this brings the marginal take rate up to about 21% when all is said and done. That’s pretty good! But that’s about what you’d pay on a salary, excluding EI and CPP.

The other option is paying yourself a salary.¬†Most who ask this question (at least my clients) own more than 10% of the shares of the company, so they aren’t eligible for EI. However, everyone must pay CPP. The CPP rate is 4.95%, after the exemption of $3500 (earnings), and up to a maximum of $2,306.70 in CPP payments¬†for each of the corporation and the employee. This is a total of $4,613.40. This does give you the advantage of now having contributed to CPP and can, therefore, collect (claim) it later in life. And earned income is also eligible for RRSP contributions, which can reduce taxes payable. (Amounts contributed to an RRSP are taken directly out of earned income and are not taxable until withdrawn from the RRSP.) What it really comes down to is what your goals are with your business.

There are other issues, such as how your balance sheet and income statement will then look to outsiders (say if you’re trying to get a business loan). And how you can control how much you take from the business, using these strategies for tax deferrals (which allows better cash flow in the current year so taht you can build your business), and more. Yes, it does start to sound complicated! Of course that’s why you should have an accountant to help with these decisions. It’s all part of financial planning, and your goals need to be expressed in order to know the best route for you.