Income As A Salary Or Dividends

  As an owner of a corporation, you need to compensate yourself, and this can be done either through a salary or issuing dividends or a combination of both. 

A Salary is a company expense where the company remits taxes to CRA employee and employer portion. The income that you then earn from this salary is considered employment income and so you receive a T4 slip for the earned employment income from the corporation.

This company expense reduces the corporation’s taxable income and the corporate tax owning. Therefore, it is less tax payment burden for the employer. The Canada Pension Plan (CPP) contributions are also mandatory by both the company and the employee, and this will then be used to calculate government pension when you, the owner, retire. This is good for the future when you want to collect CPP, but it is an upfront cost for the employee and the corporation.

Another benefit of paying a salary is that it builds RRSP contribution room, allowing you to contribute to an RRSP, of which approximately 25% of it, will be paid back as tax refund, whereas dividends do not create RRSP contribution room. There are fewer surprise tax bills at report filing time, since the income tax is withheld on salaries, so when you file your personal tax return, the tax on your income will have already been paid. When a salary is paid, it provides access to certain deductions, such as childcare expenses and other tax credits which require the individual to have earned employment income. A disadvantage of salaries is that the tax brackets for personal income are higher than dividends.  

  Dividends are payments to shareholders of a corporation that are paid from the after-tax earnings of the company. This means they are not an expense for the corporation and thus do not reduce the taxes owned since the taxes have already been paid. To actually pay a dividend the corporation must declare a dividend and then transfer the money from the corporation to the shareholder’s personal account. This makes dividends easier to manage, as the owners’ draws will be used for dividend declaration and T5 issuance by Feb 28th of the following year. There can be a cost reduction to the corporation and shareholders since there is no need to pay CPP. For the personal tax side, dividends use a dividend tax credit which results in a small impact on the personal tax return. A disadvantage of dividends is that they are not considered earned income and so certain programs and tax credits are not eligible for the shareholder, such as maternity and parental leave benefits, moving expenses, and childcare expenses. Another disadvantage of dividends is the need to pay tax installment since dividends do not require income tax to be withheld at the time of payment. Therefore, the shareholders may be required to pay tax installment to remit the tax from the dividends earned.  

Both methods have their advantages and disadvantages, so it depends on the needs and situation of each owner to decide on a certain reimbursement plan for the corporation owners.