When tax planning for your next tax return, you may want to keep in mind whether to earn income through salary or dividends.
The owner or manager must determine the remuneration they wish to receive, and must therefore determine the optimal salary and dividend combination to maximize their cash flow. To avoid retroactive tax planning, it is best to connect with your accountant on this matter and they can advise which the best option is.
Salaries/bonuses and dividends are the most common methods of remunerating the owner/manager. Many owners provide themselves a payroll, just like their employees, and others may pay out dividends to themselves, or a mixture of the two. Below lists the differences of each:
- Salary is subject to tax deductions and charges through the personal tax return. Dividends are paid out of the retained earnings of the company had have already been subject to corporate tax. A dividend tax credit is then given to the owner through their personal tax return which is equal to the taxes paid at corporate level.
- Bonus should be paid out within 180 days of the fiscal year-end; otherwise it will be added back to the corporation income.
- Advantage of dividend is to split income with family members who directly own the stocks in the corporation. Another advantage of dividend is that CRA does not do test the reasonability as in the case of salary.
- Earning a salary allows for providing pensionable earnings for CPP purposes and EI premiums, but both portions of CPP will need to be paid, both the employer and employee portions. On the other hand, dividends are not subject to these payroll deductions, as well as workers’ compensation and provincial payroll/health services.
- A salary offers benefits in contribution to RRSP by gaining RRSP deduction room, and as a result, these investments come with creditor protection. Dividends do not exercise this benefit.
When it comes to the time to filing taxes, working with your accountant will be your smartest decision. They will be able to calculate what would be the most beneficial combination of salary and dividends that results in the highest amount of cash left after taxes.