Books ’N’ Billing offers full-service, cloud-based, bookkeeping services to sole proprietors, limited liability partnerships, and small corporations within Saskatchewan. Are you a small business owner? Save yourself the stress and let Shelby Prescesky the owner of Books 'N' Billing help you get your business's books in order. Books N Billing is a Trusted Saskatoon Bookkeeping & Tax Services Specialist. In this article, she shares the difference between dividends and salary.
Dividends Vs Salary?
If you own an incorporated business in Canada, you have the option to pay yourself through dividends, a salary, or a combination of both. In this article, we will look at the difference between these methods of payment and the main advantages and disadvantages associated with each. We will also see some common scenarios for when a business owner may choose one method over the other.
Salary/Wages
If you are paying yourself a salary or wage, the payments become an expense of the corporation and then employment income for you personally – at the end of the year, you’ll get a T4 slip outlining your taxable earnings and deductions. The expense reduces the corporation’s taxable income, which in turn reduces corporate taxes owing.
To pay yourself a wage, the corporation will need to register a payroll account with the CRA, and then the corporation will need to withhold source deductions from each of your paychecks to later remit to the federal government. Additionally, the corporation will have to prepare T4 slips at the end of each calendar year to record your work for the year.
Why Choose Salary
Paying yourself a wage can be a way for you to earn a steady and predictable personal income. Some additional advantages of using this method would include:
RRSP Contribution Room; Paying yourself a wage will allow you to build an RRSP contribution room while dividend payments will not create this.
CPP Contributions; this is a double-edged sword, while wages will allow you to contribute to the Canada Pension Plan, as the owner of the corporation you will also be responsible for the employer’s portion of this contribution.
Fewer Surprise Tax Bills; Income tax is withheld from each payment and remitted to the Receiver General. When you file your personal tax return you will have already paid income tax and will avoid a surprise personal tax bill. When paying dividends, income tax isn’t withheld and remitted which often creates personal taxes owing in April.
When Applying for a Mortgage; When you are attempting to qualify for a mortgage, banks like to see steady, predictable income. Earning employment income like this will help show that steady income, whereas dividend income may not be looked at as favourably.
Dividends
Type of Transaction
Dividends are payments to shareholders of a corporation that are paid from the other tax earnings of the company. This means that dividends are not a corporate expense and do not reduce the corporate taxes paid. The flip side is that dividends carry less personal tax liability than wages because they come with a dividend tax credit.
In practice, paying dividends to shareholders of a corporation is fairly easy. Dividends are declared and cash is transferred from the corporate account to a shareholder’s personal account. Each year, the corporation must prepare and file T5s for any shareholder who received dividends.
Where it gets tricky with dividends is that they are issued and paid based on share ownership. As an example, of Terry’s Tulips :td. Want to issue $100,000 in dividends to the owners of its Class A common shares, it must do so based on the percentage of ownership of these shares. So, if Terry owns 40% of Terry’s Tulips class A shares and Teagen own the other 60%, then Terry would receive $40,000 and Teagen would receive $60,000. This can make it difficult to allocate different amounts of income to multiple shareholders of they all own the same class of shares.
Why Choose Dividends
Paying dividends can be a simple way for business owners to withdraw money from their corporation. Some key advantages include:
Lower Cost; Paying dividends removes the need to contribute to CPP, which reduces corporate and personal costs. The downside is that it does not allow you to contribute to the Canada Pension Plan program.
Simplicity; if you own 100% of your corporation, you can just declare a dividend and transfer cash from the company to your personal account without the need for payroll or remittance of source deductions.
Less Chance for Payroll Penalties; Payroll remittances are relentless. Usually, they have to be paid each month and late payments come with high penalties. Paying dividends eliminates the chance of late or missed payroll remittances. That being said, filling of T5s still must be completed on time once per year when paying dividends.
Which Method Creates Less Tax?
So, the main question becomes “which method allows me to pay less Tax?”. While this is a very important question to ask, changes to the legislation beginning in 2018 have made it more difficult to reduce taxes by cheesing one method over the other. Often, the results of calculations show a fairly minimal tax saving one way or another, and there is a reason for that.
Integration
There is a tax concept called integration that legislation aims to implement. The main idea behind this is that there should be little to no difference in the overall income tax paid (personal + corporate) when comparing dividend payments and wage payments of the same amount. This works by;
Wages reduce corporate taxes, but in turn create higher personal taxes than dividends.
Dividends do not reduce corporate taxes but create less personal taxes than wages.
Dividend Sprinkling
In the past, corporate shareholders could skirt the issue of integration and tip the scales of tax savings in their direction by using a technique called dividend sprinkling. This was accomplished by spreading out dividend payments to a lower income earning spouse or adult family member. Because the spouse or adult family member are in a lower tax bracket than the person operating the business, there would be less personal tax to pay on their dividend income.
Now that it is more difficult to implement dividend sprinkling, it is especially important to consider the qualitative factors discussed earlier when deciding which method of payment to use.
Common Scenarios
Lastly, let’s look at a few common scenarios that we see and discuss what you might consider as a business owner in each case.
- Bad at Administrative Tasks; If making payments on time is a weakness that you have, then it may be easier and less costly to pay yourself using dividends. Wages require the regular, on-time payment of source deductions. If source deduction payments are missed or late, the penalties can add up quickly.
- Qualifying for Financing; If you plan on purchasing a home in the near future and know that you will need to qualify for a mortgage, it may be better to pay yourself as an employee (wages/salary). Banks like to see steady income more than sporadic dividend payments.
- Having Children / Parental Leave; If you plan on having children sometime soon and you would like to earn Maternity or Parental Benefits, then it may be better to earn income through wages. This is because withholding and remitting employment insurance premiums can enable the employee to collect maternity or parental benefits.
- Working Income Tax Benefit; The working income tax benefit is a refundable tax credit intended to provide tax relief for eligible working low-income individuals and families. It may be beneficial to pay yourself a small salary from your business to trigger this tax credit on your personal taxes. Consider this if you have low personal or family net income for the year.
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