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Independent Business Owner Income: Salary or Dividends?
You Have the Choice of One or the Other, or a Mixed Income.
From the basis of a registered business corporation, you must decide how to pay yourself: a business salary, payment in dividends, or a mix of both. It is important to know the advantages and disadvantages of the three systems.
The Owner Takes a Salary: Pro and Con
Now that you have the advantage of a personal salary with which to plan and live, you must know the terms that apply.
- You pay into the Canada Pension Plan (CPP) in Canada. The good news is that retirement will be enhanced by a monthly pension, the amount dependent upon duration and amount of contribution. This may be an important incentive to become your own salaried employee.
- Your salary paid out will be a tax deduction for the corporation.
- Should you have an income, you can do income splitting with a family members, spouse and children.
- You can invest in others plans such as RRSPs and TSFAs from a salary.
The disadvantages to becoming a salaried employee must be weighed.
- The personal income is 100% taxable, unlike dividends which are taxed at a lower rate.
- CPP will demand payments as both employer and employee. Therefore, a salary might mean you are incurring a net loss.
- As an employee taking a salary, you will have to set up a Payroll account with the Canada Revenue Agency and find time for the paperwork.
- By paying a salary and not dividends, for you will be unable to carry back a business loss in the future, whereas you could by paying in dividends.
The Owner Takes Dividends: Pro and Con
You must consider the advantages of taking corporate dividends.
- Dividends are taxed at a lower rate than salary, resulting in lower tax payments.
- Dividends can be declared at any time, allowing for smoother tax organisation.
- You will save on CPP payments and save money.
- Dividend payment is simple by writing a cheque to yourself by the corporation at the end of the year, updating the corporation’s minutes and preparing a director’s resolution for the amount paid. Straightforward.
There are disadvantages you must be aware of in taking dividends.
- You will not receive CPP for the years you were taking dividends when you retire.
- You will save on CPP payments and save money.
- You will not have other personal income tax dividends afforded to salaried employees such as child care expenses.
The Owner Takes a Mix of Salary and Dividend: Pro and Con
- Business salary bonuses may be paid out to keep corporate earnings down below $500,000, and dividends will be paid if more income is required. That amount is the small business limit, for above that the tax rate his higher.
- Payment of salary to the owner can reduce the corporate income to stay below $500,000.
- The choice between salary and dividends is the owner’s choice. Factors such as income level, cash flow needs, predicted corporate income for the year, the importance of RRSP and other income deductions, and age should be weighed before deciding.
- Procuring professional advice of a lawyer, an accountant or tax planner is advisable.
Formalise Your Business: Name, Register and Insure
- Decide the legal structure of your business, as a corporation or a sole-proprietorship. If you incorporate, sign documents after the corporation’s establishment.
- Choose a business name and register it.
- Insure your business. There are many types that cover different areas. Make sure you are covered for all your concerns by consulting more than one agent. Not having insurance can lead to disaster.
- Open a bank account specifically for the business.
- Do not conflate home and business matters.
Paying Yourself From a Sole Proprietorship or Partnership
Sole proprietorships and partnerships cannot issue dividends, nor can they be salaried employees and receive paychecks with appropriate deductions, for there is no distinction between ‘business’ and ‘personal’ income.
What you make is just that; all income generated is reported on the personal income T1 form.
What you make is just that; all income generated is reported on the personal income T1 form.