Salary vs. Dividends for Small Business Owners 0

Posted On February 20, 2025, by Trevor Buttle

Running a small business comes with a variety of financial decisions, including how to pay yourself. As a Canadian small business owner in Ontario, understanding the differences between salary and dividends can help you make an informed choice that aligns with your financial and tax planning goals. Below, we explore the key aspects of salary and dividends. We also discuss how an Accountant can support this decision-making process to help you decide which method suits your circumstances best.

What Are Salary and Dividends?

Salary: A salary is a regular payment made to you as an employee of your corporation. It is considered employment income and is subject to source deductions such as Canada Pension Plan (CPP) contributions and income tax withholding. Salaries are reported on a T4 slip.

Dividends: Dividends are payments made to shareholders from the corporation’s after-tax profits. As a business owner and shareholder, you can receive dividends, which are reported on a T5 slip. Unlike salary, dividends are not subject to CPP contributions or payroll taxes withholdings (source deductions).

Tax Implications for Salary vs Dividends

Salary: Salaries are a deductible expense for the corporation, reducing its taxable income. However, the income you receive is taxed at your personal marginal tax rate. Salaries also contribute to CPP, which provides benefits such as retirement pensions and disability benefits.

Dividends: Dividends are paid from the corporation’s after-tax income and are subject to dividend tax credits at the personal level. This integration system helps reduce double taxation. Dividends do not create RRSP contribution room or require CPP contributions.

Salary: Pros and Cons

Pros:

• Generates RRSP contribution room, allowing you to save for retirement.
• Provides stable and predictable income.
• Contributes to CPP, which can offer long-term benefits.
• Salaries are a deductible expense for the corporation, reducing corporate tax liability.

Cons:

• Subject to payroll taxes and CPP contributions.
• Requires regular payroll processing and remittances to the CRA.
• May result in higher personal tax rates if your salary places you in a higher tax bracket.

Dividends: Pros and Cons

Pros:

• Not subject to CPP contributions, reducing overall tax costs.
• Simpler to administer compared to payroll.
• Benefit from the dividend tax credit, potentially lowering personal taxes.
• Flexibility to time payments to manage personal income taxes.

Cons:

• Does not generate RRSP contribution room.
• Does not contribute to CPP, which can affect long-term benefits.
• Dividends are not a deductible expense for the corporation.
• May complicate financial planning due to variability.

Factors to Consider/Why You Should Work With an Accountant

Choosing between salary and dividends involves several factors, including:

• Corporate and Personal Tax Rates: Understanding the combined tax impact on you and your corporation is critical. While dividends may result in lower personal taxes due to the dividend tax credit, salaries can provide significant benefits, such as RRSP contribution room and CPP benefits. You should also consider that Dividends are paid with “after-tax” dollars from the corporation (corporate tax is approximately 12% on Small Businesses in Ontario).  Therefore, you need to consider the corporate tax paid on top of the personal tax paid, to have a true comparison to just receiving salary.
• Retirement Planning: Salaries contribute to CPP and generate RRSP contribution room, making them more advantageous for long-term retirement planning. Dividends, on the other hand, do not support these benefits but offer tax flexibility.
• Cash Flow Needs: If you require a steady income, a salary offers consistency, while dividends allow for flexibility, especially when timing payments to manage personal tax brackets.
• Compliance Requirements: Salaries require payroll administration, including remittances to the CRA, while dividends are simpler to administer but may require careful planning to avoid tax inefficiencies. Additionally, drawing dividends may require that you make tax instalments quarterly on your personal taxes for the following year.

Why Work With an Accountant?

The decision to pay yourself through salary or dividends can have significant financial and tax implications. An accountant will:

• Evaluate Your Financial Situation: By analyzing both your personal and corporate finances, an accountant can determine the most tax-efficient strategy specifically for you.
• Plan for the Future: Accountants may provide tailored advice on retirement savings, cash flow management, and long-term financial planning.
• Ensure Compliance: Navigating CRA regulations can be complex. An accountant ensures all filings, deductions, and payments are handled correctly to avoid penalties.
• Provide Strategic Advice: Beyond tax savings, accountants offer insights on how your payment strategy fits into your overall business and personal goals.

Working with an accountant is crucial to manage these intricacies. An accountant can evaluate your unique financial situation, project tax liabilities, and develop a payment strategy tailored to your goals. They can also ensure compliance with CRA regulations, avoiding potential penalties.

Conclusion

Both salary and dividends offer distinct advantages and trade-offs for small business owners. The right choice depends on your financial priorities, tax situation, and long-term goals. Consulting an accountant will help you determine the optimal approach, ensuring that you are maximizing tax efficiency while meeting your personal and corporate objectives.

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This blog is not meant to provide specific advice or opinions regarding the topic(s) discussed above. Should you have a question about your specific situation, please discuss it with your GBA advisor.

GBA LLP is a full-service accounting firm in the Greater Toronto Area, but we primarily service all of Ontario as well as the rest of Canada virtually, except Quebec. Our team of over 30 provides audits and reviews of financial statements, compilations of financial information, and corporate tax returns.  We provide specialized corporate tax and succession planning for small and medium businesses, in addition to general advisory services.

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