Once a company is operational, the owner(s) must choose their method of compensation. They have the choice between two income types: salary or dividend. These two methods of compensation have their own distinct characteristics. Let's take a closer look at the differences between these two incomes.
Dividends and salary: two income types
What is a dividend?
A dividend is a share of net profit that is distributed among the different shareholders of a company. It cannot therefore be considered an expense that reduces the taxable income of the business as a salary can be.
Salary reduces the profit in the earnings statement of the financial statements, while the dividend payment reduces the retained earnings in a company's balance sheet.
What is a salary?
A salary is an amount paid in exchange for work done by a person under an employment contract.
Salary is considered an expense in the earnings statement of the financial statements.
The impacts of taking a salary
Taking a salary involves the collection of several social costs. In Quebec, both the employer and the employee must pay contributions. First, there are the Régie des rentes du Québec (RRQ), the Quebec Parental Insurance Plan (QPIP) and the Health Services Fund (FSS).
These contributions represent additional costs but allow the shareholder to benefit from several advantages. These advantages also benefit the business since the salaries payed are deductible.
Regarding deductions, there are some that concern federal child care, the QPIP, the RQQ and the Registered Retirement Savings Plan. These deductions are applicable for salaries but not in the case of dividends.
It's worth noting that taking a salary also incurs a cost for the employer, since they have accrued expenses as well as employee contributions to consider. In the industry, you often hear that paying $100 of gross salary to a worker costs the employer about $115 and the employee receives between $55-75 net of that amount after federal taxes and contributions.
The big weak point of salary is taxation. In fact, the shareholder's income is taxed at a rate of 49.97% in Quebec, which is a very high rate. Our corporate tax return services can help you in your efforts. You can also take advantage of our tax software that allows you to easily complete your T2 and Co-17 returns.
The impacts of taking dividends
For the shareholder, a dividend is taxed far less than a salary taken by the shareholder. Salary is subject to taxation while a tax has already been paid by the company for the dividend.
There are two types of dividends: qualified and ordinary.
Qualified dividends are paid when the business earns income that is not eligible for the SBD (Small Business Deduction). The shareholder will see his income taxed at a lower rate (up to 35.22%) when taking a dividend, since the company pays a higher tax (26.9%).
Ordinary dividends are paid from business income eligible for the small business deduction or from investment income. The shareholder's income is taxed at a higher rate than for qualified dividends in this case.
Ordinary dividends and qualified dividends are not considered a deductible expense for the company. The personal tax rates are therefore lower than those applied to a salary.
Dividends and salary: two distinct incomes
The choice of compensation method is an important issue. The owner’s situation should be analyzed in-depth by a specialist to determine which compensation method, salary or dividend, will best suit them. If you want to assess the personal and tax factors that concern you, don’t hesitate to contact our team accounting experts.