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How you would pay yourself as a small business owner is a question that requires contemplation. You can pay yourself a salary, or can receive dividends, or a combination of both. However, the decision on salary vs dividend is influenced by a variety of factors such as personal and corporate tax structure. Considering this, each way of paying yourself comes with pros and cons. Moreover, in almost all cases there is a discrepancy of a percentage or two that can work in your favor or against you, and this potentially influences your decision on how to compensate yourself. To provide you with clarity on the subject here is a comparison of paying yourself in salary vs dividend.
Compensating yourself in Salary
As mentioned above you can compensate yourself with a salary as well as with a dividend. If you choose to pay yourself salary, you can reap certain benefits but will also have to bear the disadvantages that come with it.
By compensating yourself in salary, you ensure a personal income. With a personal income, you will be able to contribute toward the Registered Retirement Savings Plan (RRSP) and Canada Pension Plan (CPP). As your CPP is based on how much and how long you contribute, paying yourself in salary will help you consider this important retirement plan. Regarding tax benefits, the salary or bonus you pay yourself will be a tax deduction for your small corporation. Additionally, you can implement income splitting by paying salary to related employees such as a spouse or children and avail of income tax benefits.
Having a personal income may also turn out to be a drawback. Unlike dividends, which are taxed at a lower rate, salary is a hundred percent taxable. This might increase your tax load. If your business profits vary every year, paying yourself with a salary can result in taxation issues, as you will not be able to carry forward business loss. With regards to CPP you will have to contribute toward it as an employer as well as an employee. Furthermore, it will also require you to set up a payroll account with the Canada Revenue Agency.
Compensating yourself in Dividends
Many business owners choose to compensate themselves via dividends. Paying yourself in dividend comes with the following advantages and disadvantages.
Dividends are taxed at a lower rate than salary hence you save yourself from the load of personal tax. Additionally, when paying yourself in dividend, you will not have to pay toward CPP, which will save you money. Unlike salary, paying yourself in dividend is much simpler. You write a check to yourself from the company, update your minutes books, and prepare a director’s resolution for dividends paid.
Apart from the benefits you reap, there are certain disadvantages. Compensating yourself in dividend does not allow you to contribute toward retirement benefits like RRSP and CPP. Dividends can also disallow you from enjoying the benefits of personal income tax deductions.
Whether you pay yourself in salary or dividend is completely dependent on the type of business, and your personal financial circumstances. A detailed understanding of types of corporations and related tax structure, as well as your personal financial management, will help you make the best decision. Guidance of a financial and tax consultant is recommended to help you choose the best from salary vs dividend.