If you run a business, there are two ways that you can pay yourself – through personal salary or dividends. Either way, you are going to have to pay taxes on that income. However, there are different tax rates for these different forms of income.
So, you might be wondering, which form of income might allow you to defer or save some money in the long run? Alternatively, you may have some personal objectives, and deferring or saving taxes is not on the table. Below I discuss the pro and cons on each type of income.
There are some benefits to using dividends as a form of income. For example, they are not subject to payroll deductions (such as CPP and EI premiums, taxes, etc). In this way, dividends are a very direct method of compensation.
Also, dividends are taxed differently than salary, which may reduce your personal income taxes. Dividends can also be used to cleverly split income with family members who may own shares in the corporation. However, you must avoid paying dividends to anyone under the age of 18 to avoid the dreaded “kiddie tax”, meaning getting taxed in the higher bracket.
Salary is subject to all sorts of deductions. However, it does offer some benefits that dividends do not. For instance, salaries provide pensionable earnings for CPP purposes, that is, assuming you want a pension. They also create RRSP contribution room to allow you to invest in retirement products while at the same time getting a reduction in taxable income. Dividends on the other hand do now allow for that. Salary also helps spouses to deduct childcare expenses while dividend income will not allow for that.
When determining the optimal mix of dividends, salary, or a combination of both, it is best to contact your tax advisor so that the relevant facts and important personal information are taken into consideration.