Salary vs. Dividends is a very common question asked by all clients when preparing tax-plans for them. Today’s blog will outline the top factors to help you determine whether you should be paying out a salary or dividend from your corporation. There are quite a few variables that have to be analyzed to determine which works best for each individual client.
Are you applying for Mortgage or a Renewal?
The first point you should consider in Salary vs. Dividend is will you be purchasing a home with a mortgage? Or, do you have an upcoming mortgage renewal? This is important because financial banks verify your net income and source of income from your personal income tax returns. The source of income is generally required to be earned income (also known as secured income) unlike salary dividends are NOT considered to be earned income, this means you cannot rely only on dividend income for mortgage purposes. Sometimes speaking with a bank account manager in advance and explaining you have an owner managed corporation can allow them to accept dividend income.
Are you relying on RRSPs for Retirement Savings?
The second point to consider in Salary vs. Dividends is do you wish to contribute to RRSPs? RRSPs are a registered retirement savings plan and requires sufficient contribution room limit each year. This contribution room limit is increased based on your earned income each year, this means you will need some salary if you want to continue contributing to this plan.
Do you have personal tax deductions requiring a salary?
The third factor in Salary vs. Dividends you should consider is do you have any child care expenses or moving expenses. These expenses can be deducted on your personal taxes only against earned income, this means you cannot rely only on dividends income to maximize this personal tax deduction.
Do you have any Tuition Tax Credits available?
The fourth factor you should consider in Salary vs. Dividends is do you have any tuition tax credits? If so, you will need to strategically tax plan if you will be only taking dividends from your company to ensure your dividend tax credits do not go to waste on your personal tax return. This is important because dividend tax credits cannot carry forward and you will not minimize your personal taxes if you do not tax plan for this one credit.
Do you wish to contribute to the Canada Pension Plan?
The fifth point to consider in Salary vs. Dividends is do you wish to contribute to the Canada Pension Plan? If you have no other source of retirement savings, you should be careful to not rely only on dividend income because although it is exempt from CPP contributions, you want to make sure you have some source of secure income during your retirement years. (i.e Real estate, RRSPs etc.) Paying a Dividend now will not entitle you to sufficient CPP benefits later during retirement age.
Will you be deducting expenses as an employee in your company?
Certain expenses in your corporation can only be deducted if they were paid to an employee of the company. An example of this is the tax-free car allowance and medical benefits, this means you cannot rely only on
Dividend income to maximize your corporate tax deductions.
Overview of Salary vs. Dividends in Practice:
Now that you know the major factors that help determine whether you should pay out a salary or dividend from your company, let’s consider what the most common solutions found in practice.
There are generally few clients who prefer to only take salary from their company. It’s usually clients who are planning to rely on the Canada Pension Plan and RRSPs in their retirement age. It’s also important to consider that if you have worked full-time for a long portion of your life, you do not want to minimize your maximum entitlement to CPP by suddenly not contributing to CPP in your last few years of earning income; you are better off continuing to take some salary at minimum.
Salaries require more accounting work as you need to prepare payroll schedules and submit monthly remittances to the CRA. There can be situations where a salary is more beneficial over dividends, for example when your corporation’s net income exceeds $500,000 dollars.
For dividends, the first $35,000 dollars of dividends are tax-free if you have no other source of income, this works really great for income splitting with family members because you can multiply it. Another major reason dividends are popular is that many individuals wish to avoid paying CPP tax and have other sources of retirement savings built up for retirement age such as real estate property. The only drawback in dividends after the top factors already discussed is you have to be a shareholder of the company in order to be eligible.
By using a combination of salary and dividends in your tax-planning with your tax-accountant, you will be able maximize all your tax deductions both personal and corporate. This usually will end up being the most strategic way to go. In the Salary vs. Dividends debate, this is probably the best answer! Schedule a meeting with one of our tax-accountants to get a tax-plan made for you today!
Author: Gurrai Birdi, CPA, CGA, MBA
Gurrai Birdi is a Chartered Professional Accountant (CPA, CGA, MBA) who has years of extensive experience in public practice working with highly satisfied individual and business clients to ensure there taxes are minimized and accounting needs are fulfilled.