Whether you’re an employee or an entrepreneur, everyone depends on having an income to support themselves and pursue their interests. Employees usually aren’t able to choose what type of compensation they receive, but entrepreneurs have the option of paying themselves a salary or dividends.
To help you decide, find out more about the two types of income in this handy guide.
- Payment in the form of a salary
- Payment in the form of dividends
- Salary vs. dividends: Let T2inc help you decide!
Payment in the form of a salary
A salary is an amount paid out for work an individual performs as part of an employment contract. It appears as an expense in the income statement that forms part of a company’s financial statement.
The results of paying yourself a salary as an entrepreneur
If you choose to pay yourself a salary, the payments are considered an expense for your incorporated company. They then become employment income for you personally, which means you will receive a T4 to file your personal tax return. As the payment is a business expense, it reduces your company’s taxable income, and by extension, the amount that will have to be remitted to the tax authorities at the end of the fiscal year.
In order to pay your salary, your company will have to register a payroll account with the CRA and Revenu Québec. Each time you are paid, the company will have to make deductions at the source (pension plan, income tax, etc.) and remit them to the appropriate tax authorities.
In the industry, it’s often said that paying an employee $100 in gross wages costs the employer around $115, and the employee only receives $55 to $75 of that due to the taxes and contributions that are withheld.
The advantages of earning a salary as an entrepreneur
Paying yourself a salary can be a good way to ensure that you have a stable, predictable source of personal income.
Earning a salary enables you to accumulate RRSP contribution room, which isn’t possible if you are paid in dividends. You’ll also be able to access deductions on services such as federal child care, QPIP, QPP and the Registered Retirement Savings Plan.
Furthermore, if you want to obtain a mortgage, banks will look more favourably on you if you have a stable, predictable income. Income from dividends is generally considered to be less stable and may discourage banks from lending to you.
Finally, when you are paid a salary, income tax is automatically deducted from each paycheque. That way, you can avoid receiving a hefty tax bill at the end of the fiscal year. If you are paid in dividends, you’ll have to set money aside to pay your taxes before the deadline.
The disadvantages of earning a salary as an entrepreneur
The main drawback of earning a salary is taxation. A shareholder’s income is taxed at a rate of 49.97% in Quebec, which is very high. Our corporate tax return services can help you through the process.
You can also use our corporate tax software for a simple way to fill out your T2 and Co-17 tax returns.
Payment in the form of dividends
Definition of dividends
Dividends are shares of a company’s net profit that are distributed among its shareholders. Therefore, unlike a salary, it is not considered an expense that reduces the company’s taxable income.
There are two types of dividends:
Eligible dividends: When the company earns revenue that isn’t part of the small business deduction (SBD)
Ordinary dividends: For companies that earn revenue that is eligible for the SBD
Why choose dividends?
Salary decreases the profits listed in the income statement that forms part of a company’s financial statement, while the payment of dividends reduces the retained earnings listed in the company’s balance sheet. In terms of personal income, dividends are less heavily taxed than salaries because they benefit from a dividend tax credit.
Paying dividends to a company’s shareholders is quite simple. They are declared, and then the money is transferred from the company’s account to the shareholder’s personal account in one or more transactions.
The results of paying dividends for the company
Every year, the company is required to prepare and file T5s for all shareholders who received dividends. Neither eligible nor ordinary dividends are deductible expenses for business taxes. As such, personal tax rates for dividends are lower than those applied to a salary.
Paying dividends is a simple way for business owners to withdraw money from their company. The payment of dividends eliminates the need to contribute to the QPP, which significantly reduces how much you and your company have to pay.
Moreover, if you own 100% of your company, you can simply declare a dividend and transfer cash from the business to your personal account, removing the need to put yourself on the payroll and remit source deductions.
Salary vs. dividends: Let T2inc help you decide!
The question of which type of compensation to choose is an important one. With this information in hand, you’ll probably have a better idea of which strategy you want to adopt to earn income as an entrepreneur. Receiving a salary and receiving dividends each have their own advantages. As an entrepreneur, you’ll need to carefully assess your situation in order to determine which type of compensation suits you best.
Having a specialist on hand to help you assess your situation will ensure that you make the most optimal choice. With their help, you’ll be able to maximize your revenue and help your business grow long term.
To help you make this important decision, contact T2inc today! Our tax and accounting specialists will be able to provide you with guidance that will protect your financial future and that of your business.