A CPA answers the most common questions from Canadian small business owners
This month features Joe Collins, an accountant, and founder of Avalon Accounting. He became an accountant and started Avalon because he believes small business owners deserve a better deal – up to date information about their business and a service provider who focuses on their specific needs.
What’s the best way to pay myself from my corporation?
Disclaimer: This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice.
Despite what you might hear, there are only 2 ways to pay yourself from your corporation in Canada: dividends or salary (sorry, you can’t be a contractor for a corporation you own).
Unfortunately, it’s not as simple as figuring out which method will have a smaller tax payment – although, that is an important factor that we’ll cover as well.
Simply put, a salary; also known as wages or employment income, is income that is run through payroll. You pay wages and withhold the tax and Canada Pension Plan (CPP) payment. Income is then reported on a T4 to include on your personal tax return. These are expenses to the company and will reduce your net income and therefore the corporate tax that you must pay.
A dividend is a distribution/payment from the after-tax profit of your corporation. If you pay yourself this way, the company does not get a tax deduction for these, so they don’t reduce the corporate tax that you owe. Dividends can be paid throughout the year and are reported on a T5, which is then included in your personal tax return.
To choose an option that works best for you and your company, you’ll need to take the following into consideration:
- Administration:
- Wages must be run through payroll, so they have a higher administrative burden than dividends.
- Dividends can be declared at any time and have a simple filing with CRA.
- Saving for retirement:
- Wages create a Registered Retirement Savings Program (RRSP) contribution space, allowing you to save and defer tax to later in life.
- Dividends create no RRSP space, so this tax shelter won’t be available if you just pay yourself dividends.
- Tax surprises:
- Wages create fewer tax surprises. You subtract the tax off each pay cheque which lowers the chance that you’ll owe money when you file your end of year return.
- With dividends, no tax is withheld. This means that when you draw your dividend, you don’t take a percentage out of the total amount to accommodate taxes. Come April, you may have a hefty tax bill.
- Canada Pension Plan (CPP):
- This can be a pro or a con depending on your thoughts about CPP. Wages allow for you to contribute to (and later collect from) CPP.
- With dividends, you don’t contribute (or collect). This means if you pay dividends, you may have more cash in your pocket now, but less later.
- Other government programs:
- The system is designed so that you pay wages for work that you do in your business where you take dividends for the profit your work produces.
- With COVID-19, we saw that many government subsidy programs were based on wages paid and not dividends. Many business owners who paid dividends only, were left out of these subsidies. Ouch!
- Taxes – depending on which province you’re in, there may be some slight differences to the below:
- Although taxes are the first thing people think about, it tends to rank lower on our list. That’s because the Canadian tax system is designed so that whether you pay yourself a salary or a dividend, you will end up paying around the same tax overall.
- With dividends, you pay some tax at the corporate level and the remainder at the personal level.
- With wages, you only pay taxes at the personal level.
Our recommendation: There’s no one-size-fits-all. It’s important to take all these factors in and apply them to your own situation. If it’s strictly about money, we have some content on Avalon Accounting’s YouTube channel that can help you make a more informed decision. You can also sign up to our weekly newsletter for tax and small business tips here.
