An incorporated business is a separate entity, and the income from the business belongs to the corporation, not the business owner. The small business owner gets the remuneration in the form of salary, dividend or a mix of both. What is the most tax-efficient way to withdraw money from your business?
There are both advantages and disadvantages to salary and dividends. In this article, we will weigh the two options in some scenarios to help small business owners make informed decisions on the best way to pay themselves.
When Small Business Owners Pay Salary to Self
You can pay a salary to yourself as a business owner. You must set up a payroll account with the Canada Revenue Agency (CRA) for this. The account number of your corporation account and your payroll account are the same except for the last two alphabets of the account number, which are ‘RC’ for the corporate account and ‘RP’ for the payroll account.
When you pay yourself a salary, it is deducted from the corporation’s revenue and not taxable in its account. But since it is your income, you must pay tax on that earned salary at an individual tax rate. It helps avoid double taxation.
Advantages of Salary Income
- While paying a salary, you contribute towards the Canada Pension Plan (CPP), which will ultimately increase your retirement corpus.
- Another way of contributing towards your retirement plan is through Registered Retirement Savings Plan (RRSP). The RRSP contribution depends on the prior earned income. Since a dividend is not considered earned income, it is better to take a salary to increase the RRSP contribution.
- RRSP contribution is also eligible for a tax deduction. So it is always better if you have a salary income.
- Salary income is proven evidence of your earnings and helps you get better financing like a mortgage or increased line of credit.
Disadvantages of Salary Income
- When investing in Canada Pension Plan (CPP), you and your company contribute towards it, thereby reducing the current cash flow.
- Salary require more administrative work like setting up a payroll account, paying a regular salary, and deducting CPP.
When Small Business Owners Pay Dividends to Self
A dividend is a part of the profit you pay yourself for being the shareholder of your company. It might vary based on the earnings of the company. The dividend payment process is not as tedious a job as a salary. Unlike salary, you need not require a payroll account with the CRA to give dividends. Issuing a check from the company’s account to your personal account may suffice. As the dividend is paid from the corporation’s after-tax income, it is not tax deductible for your business.
Advantages of Dividend Income
- Unlike salary, the dividend is not considered earned income and hence does not require remittance towards CPP. It saves your cash flow.
- The tax rate on the dividend is lower than the tax rate on salary income, bringing tax savings.
- You can pay yourself dividends based on the corporation’s income. It allows you to optimize your tax position.
- Dividend payment is comparatively easier than salary.
Disadvantages of Dividend Income
- Since a dividend is not considered earned income, you cannot invest this amount in an RRSP or CPP and claim a tax deduction.
- Dividend income is not substantiated evidence of your earnings. Hence it does not help you in obtaining loans from the banks.
Choosing The Right Mix of Salary And Dividend
Keeping small portions of all possible options in your portfolio is always a tactful decision to maintain a good balance. Most business owners keep a mix of both salaries and dividends to pay themselves. While salary gives you a monthly assured earning, dividends provide extra earnings for increased personal expenses. The decision lies on various factors like projected annual earnings of the company, your personal requirement, personal investment, growth of the company, and required cash flow. Based on these parameters, you can determine the ideal ratio of salary and dividend from time to time.
The ultimate decision of how much you pay yourself in the company is yours and is based on its financial position. You should consider the penalties and benefits involved in every situation to get the best possible combination. You can always take the help of a professional tax planner and accountant to save your hard-earned money from CRA’s tax claws. After all, all small business owners work to reap better profits from the company.
Contact Ford Keast LLP in London to Help You with Corporate and Personal Tax Planning
Talk to a professional accountant to help you plan the best for you and your company’s earnings and funding requirements. At Ford Keast LLP, our professionals can provide you with services such as bookkeeping, maintaining documentation, preparing accounts and tax filing, and helping you with the administrative burden that comes with a salary. To learn more about how Ford Keast LLP can provide you with the best accounting and tax planning expertise, contact us online or by telephone at 519-679-9330.