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Salary or Dividends? Now you’re the boss here’s how to pay yourself like one

Salary or Dividends? Now you’re the boss here’s how to pay yourself like one

Salary or Dividends? Now you’re the boss here’s how to pay yourself like one

Should you pay yourself in salary or dividends?

There’s a lot to think about when you are getting your incorporated company up and running. As a founder, one of the first issues you are going to want to deal with is how to pay yourself. This was certainly at the front of my mind when I launched my property company in 2014. This can be a complicated decision and you will need to balance a number of considerations.

Here’s a short guide to help you get the ball rolling.

Know your company and your own needs

There are three ways founders typically choose to pay themselves: salary (or bonus, the same considerations will apply), dividends, or a blend of salary and dividends.

Deciding which of these three is right for you will depend on the scale of your company and your own personal cash flow needs. Take a snapshot of your personal and company finances and think about your plans for your company. The clearer you are on your own needs, the easier you will be able to decide how and when to take income out of the company.

The good news is that whatever you decide will not be set in stone. As your needs change, reach out to your accountant or business lawyer to build a strategic alternative.

Know the pros and cons of taking a salary

There are a number of reasons you might choose to pay yourself a salary:

1. Cash Flow

First and foremost, if you need a larger cash-flow then you will need a salary.

2. Retirement

Another benefit to taking a salary is that you may be able to contribute to both a Registered Retirement Savings Plan (RRSP) and your Canada Pension Plan (CPP).

How old are you? Are you good at saving? These are the types of questions that will help you decide whether forced retirement savings are a priority for you.

3. Tax Savings for your Company

Your salary (or bonus) will be a tax deduction for the corporation.

If your company is a Canadian Controlled Private Corporation (CCPC) with taxable income less than $500,000 you may be eligible for the small business deduction and be taxed at a significantly lower rate. Paying a salary can help you ensure that your profits do not exceed the $500,000 cap and maintain eligibility for this discount.

4. Additional benefits

You may be eligible to claim additional benefits such as child care tax credits.

There are also disadvantages to taking a salary. You might be taxed at a higher marginal rate than if you paid yourself in dividends. You will also have complicated payroll commitments with the CRA, will have to pay both portions of the CPP as employer and employee, and your ability to carry back a business loss in future years may be diminished.

Know the pros and cons of paying yourself in dividends

The less orthodox approach to paying yourself is to take dividends.

Depending on your situation, dividends may yield greater savings to both you and your company.

1. Tax savings

Dividends are taxed at a lower marginal rate than salary.

This means that receiving income as a dividend could involve substantial personal tax savings. This is because there is little or no tax on dividend income because of personal exemptions and tax credits.

2. You will not have to pay into CPP

For some, the option to not have to pay into their CPP will be considered an advantage.

3. Tax deferral advantage

In a nutshell: leave money in the company and earn more money.

If you do not need the cash in the tax year in which it is earned, you will have the ability to leave that money in the company and take dividends at a later time. What this means is that corporate tax will be payable on the current year, but personal tax on the dividend will be deferred until later. In the meantime you can reinvest whatever the difference between the corporate tax and your personal tax is within the corporation to earn additional income.

There are some disadvantages to taking dividends. For a start, taking dividends may mean that other income tax deductions that may be important to you (such as child care) will no longer be available. And you will not be able to make contributions to your retirement plan.

There are also complications involved with not taking a salary. It may impact your ability to access bank financing for a mortgage for example, where dividends may not be recognized as sufficient income by a financial institution. This is why you need to think carefully about all of these things before reaching a decision.

Consider a blended approach.

Depending on your needs, you may be able to combine a blend of salary and dividends to maximize the tax savings to both you and your corporation. For example:

1. If you have a CCPC, you could take your income as a salary to the extent needed to make sure your corporation does not exceed the $500K small business deduction cap, and then take the remainder of your income in dividends

2. If retirement savings are not a priority for you, consider taking a nominal salary so that you are eligible for your personal employment tax credit, and then take the remainder in dividends. You can then use the company to accumulate your retirement savings on a tax-deferred basis

3. Take a salary that maximizes your RRSP and CPP deductions. If there is any income owed to you once you figure out how much salary will be required to maximize these deductions, you can take the remainder in dividends

These are complex considerations. I recommend sitting down with your accountant or business lawyer to make sure you have all of your financial affairs in order before you launch!

Finally, remember that you can change your mind! Your priorities might be totally different in a year’s time. Keep track of your personal and corporate goals as you progress with your company and revisit these issues once a year to make sure you are getting the most out of your arrangement.

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