As an owner, shareholder and active employee of your incorporated business, one of the first questions you may have is how is my corporation going to pay me as a shareholder?
There are two ways to compensate a shareholder, by either paying yourself (the shareholder) a salary or a dividend.
Paying a salary
By paying a salary to yourself, you are still contributing to the Canada Pension Plan and are creating RRSP room for future contributions. This method will put cash into your hands for all personal expenses that you need to pay for throughout the year. With payment of a salary, the company will need to make instalments of your payroll taxes (income tax and CPP) due, so to be aware of this if cash flow is sometimes low in your business at certain times of the year. Also, as a planning point for those with young families, if you pay child care expenses and are the lower income earning spouse, you may want to compensate yourself with a salary to utilize the child care deduction (child care expenses can’t be deducted against dividend income).
Paying a dividend
Dividends are paid out of after tax earnings of the company. A dividend can be declared during the year (or it is done typically at the year-end). Let’s say you only want to withdraw from your company what you will need to live on in the year (and wish for the remainder to stay in the company to build your wealth there). This amount can be paid to you as a shareholder via a dividend and taxed in your hands personally as such. Depending on the amount withdrawn, there can be some tax advantages when compensating with a dividend.
Also, if you have a spouse that owns dividend paying shares, you might be able to pay your spouse a dividend too (splitting income and potentially lowering overall taxes owed).
Canada’s tax system is built on a system of integration where it shouldn’t matter if you take one method over the other, both should result in the same amount of taxes paid. As the system of integration is not perfect, there still can be some planning opportunities and one method is not suited for all. Overall it might be best to pay both a salary and a dividend. To achieve any tax efficiencies, it is best to look at your compensation methods as an owner regularly and for best practice, give us a call to discuss before the New Year starts to give yourself plenty of time to implement a plan for the upcoming year.