As a small business owner, choosing how and when to pay yourself is one of the most important financial and tax decisions you’ll make. You may have questions about this topic, including:
- Should you pay yourself a salary or dividends?
- Is income splitting allowed?
- Which option has lower taxes?!
The answer to these questions is subjective, but our CPAs are happy to chat through your specific situation and goals with you.
VIDEO: Curtis at True North Accounting explains why this decision is one of the best opportunities to save taxes as an entrepreneur.
Who this advice is for
How your business is structured affects how you’re taxed. This blog is geared toward:
- Owner-managers of incorporated small businesses operating in Alberta
- Shareholders and their spouses who are active in their small businesses
- Service-based industries including contractors, consultants, marketing freelancers, IT and software developers, finance professionals, medical professionals, tradespeople and realtors
If you’re the owner of a small business corporation in Canada, these concepts apply to you:
- When your corporation earns profits, the cash belongs to the corporation. As the owner, you cannot use these profits for personal spending without first declaring the payment as income.
- Your corporation cannot lend money to the owners without tax consequences. If you have drawn cash, borrowed money or used the corporate bank account for personal expenses, you will want to repay the money or declare it as a wage or dividend prior to year-end, or there can be significant tax consequences.
Generally, there are two ways for owners to get paid: dividends and wages (aka salary, bonus or payroll). Here are the basics of each to help you decide which is right for you.
Click the image above for a close-up of this infographic.
Paying yourself in dividends
When you pay yourself in dividends, you’re being paid out from the profit of the business, as a shareholder, or an owner of the corporation. The corporation issues T5 slips to the owners showing the amount of dividends paid in a year. The figures from the T5 are then used to calculate tax owing on your personal tax return.
- Dividends are not a tax deduction to the Corporation. They are a distribution of profits, which means the corporation likely has taxable income.
- Dividends are taxed lower than wages at the personal level to reflect that the corporation has already paid a portion of the taxes.
- No Canada Pension Plan (CPP) or Employment Insurance (EI) is payable on dividends.
- Dividends do not create RRSP contribution room. Only earned income creates RRSP contribution room.
For simple reporting, add up all the draws during the year and file a T5 slip by February 28.
- Personal taxes on dividends are due to be paid by April 30.
- If your only income at the personal level is dividends, you can declare about $20,000 without paying any tax.
Paying yourself in wages
If you decide to pay yourself a salary (or a wage), you’re paid as an employee of your own business. You may be put on a regular payroll, or receive a one-off bonus. The corporation issues you a T4 slip indicating your annual wages. These must be filed by February 28.
- Wages are a tax deduction to the corporation, meaning the business will treat the wages as an expense.
- Wages are taxed personally at the applicable personal tax brackets. Learn about combined federal and Alberta tax brackets.
- For CPP, 11.4% must be paid on wages between $3,500 and $64,900. Half is paid by the employee and half is paid by the employer. Wages over $64,900 per year are exempt from CPP, so the maximum owing in a year is $3,499.80 each for the employee and employer.
- Owners are exempt from paying EI premiums.
- Wages are “earned income," which increases your RRSP contribution limit.
- RRSP contributions can be used to reduce your personal tax owing.
When you are an employee of your corporation, the company pays the income tax and half of the CPP for you. Monthly payroll remittances are due 15 days after the month when the owner got paid.
Which option has lower taxes?
A common misconception is that dividends are cheaper, which is the case if you only look at the taxes paid personally. But to compare apples to apples, you need to consider the tax the corporation paid, prior to paying out the dividend. We often find that wages result in less actual tax being paid, but may end up being slightly more expensive overall due to the Canada Pension Plan contribution.
Generally, total taxes on wages are lower than dividends, but wages tend to be more expensive because of the CPP.
To recap, dividends seem easier, but you still need to save a percentage of each dividend draw for your personal taxes and make corporate and personal income tax instalments. You may end up paying more tax than salary, and you must be more active in your retirement planning.
When you pay yourself a salary, you invest for retirement by paying into CPP and contributing to RRSPs. You are eligible for CPP and EI benefits, Canada Workers Benefit and COVID-19 relief. You also get your business to pay your taxes, so you owe nothing or get a refund come tax time.
How to do your payroll
There are several benefits to using payroll software for your small business. You can direct deposit to the CRA and your employees, your calculations are done for you, and you have clean records for T4s.
How to do recurring payroll remittances
- Determine the net cash in your personal bank (household budget) or gross salary amount (what you're paid before taxes).
- Calculate the amount of payroll remittances and net pay. Determine the CPP and income taxes for your tax bracket.
- Automate payments through your bank. First, you can make a monthly payment to the CRA payroll account on the 10th of each month. You can automate your net pay to be weekly, semi-monthly or monthly.
- File your T4 slip by February 28.
Learn more about CRA payroll remittances and when they are due in our Help Centre.
Take advantage of tax deferral
The bulk of tax is paid at the personal level, meaning the real tax benefit to incorporating lies in the ability to defer the personal portion of the tax bill each year. To a certain extent, the owner has the ability to decide how much tax to pay in any given year.
We recommend that you determine your basic living costs, and base your compensation on that. If there is excess cash or profit in the corporation after the owners have been paid, the extra cash can be kept in the corporation. Only corporate tax rates (11%) would apply on that excess.
Income splitting in Canada
The federal government has made some changes to the ability to split dividends between spouses. Rules for dividends now align more meaningfully to the rules around wages – dividends must be earned or must be a reasonable return on investment.
Income splitting in Canada is allowed to the extent that the dividend or wage is reasonable compensation for the effort of the spouse. Or, if the spouse is not involved in the business, the dividend must be compensation for financial risk.
Other ways to be compensated
There are a few one-off ways for owners to take cash from the corporation. These include:
- Shareholder loans: This is only if the owner has lent the company money. The repayment is not income and is tax-free.
- Management fees: If the owner of the corporation is another corporation that provides services, then management fees may be an option.
- Other tax account balances: Capital Dividend Account or Paid Up Capital (PUC)
Let us run the numbers for you
We know the laws change often and they can have a big impact on your business, so we work with you every step of your entrepreneurial journey. Our Chartered Professional Accountants (CPAs) can talk you through the pros and cons of salary or wages vs. dividends, and calculate your after-tax income under various scenarios to help you determine what’s best for your specific situation. January and February is when we calculate the amount of tax owing under dividends, and the exact amount of tax and CPP under wages for our clients. We can also give you the optimal balance of dividends vs. salary.
We’re here to provide bookkeeping and tax services to small business owners in Alberta, including everything from deductions, write-offs, expenses, tax returns, GST filing and more. If you still have questions about whether wages or dividends are right for you, book an appointment with us. We can take the stress out of tax season and help you navigate this important decision.
Read more about Starting a Business topics that may be helpful to you and your small business.
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