Tax Tip Thursday

Last week, we dealt with employers/employees who have to file/receive the T-slips for 2021; what we did not talk about was deciding how to pay yourself if you own the corporation. There are essentially 2 ways to pay yourself traditionally: salary or dividends. There are some other things you can do, but we will focus on these two for now. So let’s start with paying yourself a salary.

Advantages of Paying a Salary

• You will be contributing to CPP, which means you will be improving on your pension when you retire. Canadian Pension Plan is based on how much, and for how long, you contributed, so this can be an important retirement consideration.
• The business salary or bonus paid out is tax-deductible to your corporation.
• Besides paying yourself, you can pay your family members that work in the business.
• Paying yourself a salary creates room in both your RRSP and your TFSA.
• Banks and lending institutions sometimes prefer salary when evaluating you for lending purposes.

Disadvantages of Paying a Salary

• You must set up a payroll account and file/remit on the 15^th of every month without fail.
• A salary is 100% taxed, which could increase your tax burden personally.
• You must pay both portions of CPP, which could be $7k this year: $3,500 personally, and $3,500 as the employer.

Now let’s talk about dividends.

Advantages of Paying Dividends

• Dividends are taxed at a lower rate than salary, which can result in paying less personal tax. The 1^st $40k in dividends are pretty much tax-free personally!
• Dividends can be declared at any time, allowing you to optimize your tax situation.
• Dividends are not earned income and therefore do not attract CPP, so you are not required to pay it.

Disadvantages to Paying Dividends

• While not having to pay CPP is a benefit of dividends, it could also be a disadvantage in that you are not contributing to your CPP and therefore you are not contributing your pension.
• It also does not create any RRSP or TFSA contribution room.
• Receiving dividends instead of a salary prevents you from claiming other personal deductions such as childcare costs or home office expenses.

Another option is a hybrid, or choosing to pay both.

Reasons for Hybrid:

1. If you are interested in contributing to CPP, RRSPs, and/or TFSAs and generating a pension/savings for your retirement, you might consider paying yourself the amount of salary that allows you to pay the maximum contributions for CPP ($65k this year). Any excess monies that you want to pay yourself could be dividends.
2. If your business is VERY profitable, people use salary as a way of decreasing your corporate net income below $500k, so that you stay under the Small Business Deduction limit.

Considerations for the Best Strategy:

• Your desired Income level
• Cash flow needs, both personally and corporately
• Projected annual earnings of the corporation
• Importance of personal cash for investments and tax deductions
• Your age
• Your retirement plans
• Other income expectations, now or in retirement

These are not easy decisions.

An accountant should be hired to create the best scenario for you and your circumstances. As a business owner, how you wish to pay yourself is a personal decision that should be made based on your financial situation, as well as those items that will benefit you the most. You may decide that personal income is most important or dividends, or a mix of both. Engage a financial professional to help you determine a form of compensation that works best for you and your business. Book an appointment and we can help you create a strategy that is right for you.

Disclaimer:

This article provides information of a general nature only. It is only current at the posting date. It is not updated and it may no longer be current. It does not provide legal or tax advice nor can it or should it be relied upon. All tax situations are specific to each individual. If you have specific tax questions you should book an appointment for a 1 on 1 consultation.