Salary or Dividend?
As a business owner,
Should You pay yourself Dividends or a salary?
In this video I will share the
two most common ways that
how business owners like to pay themselves.
And What’s the pros and cons between them
so make sure you stick to the end!
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One of the biggest questions business owners
ask is what the best way is
to pay themselves if they own a business
Now we have couple options.
The first common way is through salary,
the second is through dividends,
and the third way is a shareholder loan.
In todays’ video I will focus on the first two.
And as always!
Make sure you talk to your accountant
to decide which way is best for you!
First, let’s talk about how the structure works.
You are the key employee of your company.
You have to do certain tasks
to drive the business forward.
Therefore, your company
“hires” you and pay you a salary.
And therefore,
your salary is 100% taxable
at your personal income tax.
And it’s also 100% in the company’s expense.
Now what If I take it out as dividend.
Because you are the shareholder of your company
and usually in small business
you are the only shareholder in your company.
Therefore,
when company makes money and is profitable,
the company can pay shareholder a bonus.
Note that this bonus is not an expense,
so business cannot write it off.
It’s an after tax corporate money.
Then they pay it to the shareholder.
and let me show you in numbers
Say Peter is a chiropractor,
and he is the only shareholder in his business.
Let’s say he makes $500,000 in revenue
and spend 300,000 in overhead expense.
now Peter needs 100,000 after tax income
for his own personal stuff.
Let’s see how the math breaks down.
So in order for peter to take
$100,000 net in salary.
That means he needs to have $146,000
before tax which to pay his CPP which is
$3500 and his federal and provincial income tax.
So that’s $146,000 from his company plus
his company also needs to spend another
$3500 for the employer’s side of the CPP.
That means 500,000 minus
300,000 overhead expenses minus
$150,000 for peter’s side.
The left over will be the profit which is 50,000.
This $50,000 will be then tax at
9 – 12% small business tax
depends which province you are in.
Let’s say 10% in avg.
so $5000 goes to the cra.
So the total amount of tax in this transaction
will be $5000 small business tax.
And around $42000 in personal income tax
+ $7000 of cpp which is around $54,000.
Let’s see what happens if this transaction
is declared as dividend.
Like I mentioned before dividend
is a bonus to shareholder.
So it doesn’t count as expense.
Therefore, the company have $500,000 revenue
minus the $300,000 overhead expense.
which is 200,000 profits.
Then the company needs to pay
the small business tax on the $200,000 first.
Which is $20,000.
Then we have 180,000 left and the company
will pay peter $126,000 in order for
Peter to have $100,000 after tax money.
This is a rough estimate.
Because it depends on which province you are in.
and dividend tax is another monster topic
to chat in the future.
Therefore, the total amount of tax will be 20,000
from the small business tax plus
the 26,000 from the dividend tax.
Which is around $46,000.
As you can see,
the amount of tax for both ways is very similar.
The main difference is on the CPP payment.
Because CRA wants to make sure
people to pay it in fair.
Like I always said,
CRA is always the smartest person in the room.
They always win!
Okay, so if it doesn’t matter for tax purposes,
then what is the difference?
Let’s first look at the way most people know how
to pay themselves and that is through a salary.
Everybody is familiar with this payment method
as it’s the most common.
The biggest benefit of a salary is that you get
a steady, predictable income throughout the year.
This is especially important if you’re personally
looking to borrow money from a bank
for a mortgage or a loan.
The other is that when it comes to tax time,
you don’t have to pay a huge tax bill as
you’ve made installment payments
throughout the year.
The third big benefit of paying yourself in a salary
is that you create RRSP room for yourself.
This helps you shelter some of that income from
taxes and gives you savings for your retirement.
While you can use this to offset your personal income.
Paying yourself a salary also means that
you have to pay into the Canada Pension Plan,
which is deducted from every paycheque.
This can be seen as both a benefit or a drawback
as you don’t get that money right away,
but you do get that CPP benefit when you retire.
The last consideration is withdrawing a salary
does reduce the overall financial results of
your company which can affect its ability
to retain financing or a company loan.
In other words,
if you take a salary of $10,000 every month,
then a bank might look at that as a liability
and decide not to lend your company money
which can hamper growth.
Next,
let’s look at the second way to pay yourself
which is giving yourself in dividends.
The biggest advantage is it’s the simplest way of
getting money out of your corporation
and to you personally.
If you pay a salary,
you’ll need to set up an account with the CRA,
set up pay source deductions
and remittances each month,
and complete T4 forms at the end of the year.
and the salary needs to be reasonable.
For example, you cannot hire a janitor
and pay him 200,000 per year.
and when you put some one in the payroll
say $50,000.
You have to pay $50,000 by the end of the year.
However,
dividends are paid out based on share ownership.
ultimately, here is no monthly administration
you need to worry about and so it can be simpler.
And technically you can pay yourself
anytime any amount you want.
At by end of the year,
all you have to do is file a T5 form.
Now, that all sounds great,
but one of the big things to consider
with dividend payments is
you're not paying income tax every month
like payroll.
So when it comes tax time,
you might have a very large tax bill
that you may or may not have accounted for.
If you can plan and put away that money,
that might not be a big deal,
but more than a few business owners have been
caught off guard by the amount of tax they owe
the government by the end of the year.
Paying yourself through dividends
also provides the greatest flexibility.
When the company is doing well,
you can pay out more dividends
and when it’s doing poorly,
you can keep money within the company.
This is a great benefit,
especially if your company is only
one or two years old and
hasn’t built up steady cashflow yet,
or you’re in an industry that
fluctuates season from season
Another reason why I like dividends is,
you can add your spouse as shareholder as well.
That way,
you have 2 shareholders to give dividend to.
And you don’t have to pay
2x the CPP and payroll fees.
Next you don’t have to pay into CPP
with dividend payments.
As we stated earlier,
this can be a negative or a positive.
That’s roughly $7000 per year.
If you invest that money wisely
you could end up having more money
for your retirement than if you paid CPP.
However, if you spend all your money,
you’ll run into money problems
in your golden years.
It all comes down to
how disciplined you are with your investing
One problem with dividend payments
is you won’t create any RRSP room,
so you don’t have that tax shelter
for your retirement.
However, there are other ways
you can shelter money from tax.
And if you are interested to know more,
Feel free to talk to us for more options!
Next, paying dividends doesn’t count
as a business expense so it could be
preferable when viewed by lenders,
investors, or potential buyers.
But again here,
you'll want to consider
your own borrowing needs.
The best thing to do is to
look at your goals for the next five years.
So after hearing all those info,
which way should you go for?
Here are couple questions you can ask yourself.
What kind of industry are you in?
Do you get paid regularly?
Or there is a big fluctuation in
month to month for your business?
What are your financial goals in the next 2 years.
Are you looking for tax optimization or
are you looking for big personal purchase?
How much do you need as personal expense
and how often you need it?
Therefore, remember to always
talk to your accountant before deciding
whether paying yourself a salary, dividends,
or a combination of the two
is best for you and your company.
They can help you through the process
and answer any questions you might have.
If you are interested in a free consultation to learn
how you can build tax free wealth without
market volatility to protect you and your family
using solutions that Canadian banks
don’t want you to know about,
click the link below.
You can have a direct one on one
chat with either my team and I.
And I will see you in the next video!