Whether you are an entrepreneur or simply an employee, everyone depends on having an income to support themselves and treat themselves from time to time. However, if you are in the first of these two categories of individuals, you have the option of paying yourself a salary or dividends.
In this article, learn about the difference between salary and dividends and the main advantages and disadvantages of each with respect to taxation.
Paying income in the form of a salary
If you choose to pay yourself a salary, the payments become an expense of your incorporated company and then become employment income for you personally, which means you will receive a T4. This business expense reduces your corporation's taxable income, which reduces the amount that will have to be remitted as business tax to the tax authorities at the end of the year.
However, to pay you this salary, your corporation will have to register a payroll account with the CRA and Revenu Québec. Each time you are paid, the corporation will have to make deductions at source (Pension Plan, income tax, etc.) from your salary and remit them to the appropriate tax authorities.
What are the benefits of a salary as an entrepreneur?
Paying yourself a salary can be a good way to ensure you have a stable and predictable personal income.
Furthermore, paying yourself a salary will allow you to build up RRSP contribution room, which is impossible if you pay yourself in dividends.
Salary will also allow you to contribute to the Quebec provincial pension plan, the Régie des rentes du Québec. This not only means that you will benefit from QPP benefits in the future, but also that QPP contributions represent a cost to you and the company.
In addition, when you're trying to get a mortgage loan, banks like to know that you have a stable and predictable income. Dividend income is generally not considered as stable and may discourage banks from lending to you.
Finally, when you are paid a salary, income tax is deducted from each paycheck. This avoids receiving a tax bill at the end of the year. If you pay yourself with dividends, you'll have to set aside an amount to pay your taxes before the deadline.
Paying income in the form of dividends
Dividends are payments made to shareholders of a corporation out of the corporation's after-tax income. This means that dividends are not an expense for the company. Therefore, they do not reduce the corporate income tax your company will have to pay. On the other hand, dividends are less subject to personal income tax than salaries because they come with a dividend tax credit.
In practice, it is fairly easy to pay dividends to a company's shareholders. Dividends are declared and the money is transferred from the corporate account to the shareholder's personal account in one or more transactions. Each year, the corporation has to prepare and file T5s for all shareholders who received dividends. The problem with dividends is that they are issued and paid based on share ownership, which can complicate the process.
Why choose dividends?
Paying dividends can be a simple way for business owners to withdraw money from their company. The payment of dividends eliminates the need to contribute to the QPP, reducing the costs you and your company have to pay.
Moreover, if you own 100% of your corporation, you can simply declare a dividend and transfer cash from the corporation to your personal account. In this case, there is no need to register in the payroll and remit source deductions.
Not sure what type of compensation you should choose? Speak with the experts at T2inc
In light of this information, you probably have a better idea of the strategy you need to adopt to generate income as an entrepreneur. Both salary and dividends have benefits. It's up to you to weigh the pros and cons of each method to make an informed decision.
However, if you want to maximize your revenues and grow your business, you may even want to consider a combination of both! But then you'll probably need the advice of a tax accountant.
At T2inc, we can guide you through this important decision for the financial future of you and your business. Contact us for more information!