Many business owners struggle with whether to take a salary or dividend from their business. If you look at it strictly from a mathematical standpoint, the difference is like splitting hairs. The government has made that decision pretty easy from a monetary standpoint. In the hands of the business owner, the two are virtually the same. The advantages were obvious at one point, but since 2008 there is really no difference whether to take a salary or dividend. The taxes paid in either situation are almost identical.
So if the tax numbers don’t really make a difference, what about the practical considerations when making the decision? Here are 7 things to consider whether a business owner should take a salary or dividend from his or her business.
- Canada Pension Plan Benefit? If you want a CPP benefit upon retirement, then you need to contribute. The amount is derived from your T4 earnings. It costs an individual and business about $5,000/per year. This amount can be avoided if you only dividend out to yourself as a shareholder. Many look at this as forced savings for their retirement.
- Income Splitting?– Income splitting is easier to do if you dividend out to yourself and your spouse. Obviously, your spouse needs to be a shareholder within the business for this to work.
- RRSP or Pension Contributions? To be able to contribute to your RRSP or Pension, your compensation needs to come in the form of T4 earnings, ie. Taking a salary. It may make sense to pay yourself a salary up to the maximum RRSP or Pension limit (approximately $154,611 for 2020 which allows you to contribute $27,230 which is the maximum RRSP contribution for 2021)
- Disability Coverage? If you have Long Term Disability (LTD) through your group benefits plan, this would be based upon T4 earnings. Private LTD policies take into consideration dividend income as well as salary income. If you are only utilizing LTD coverage through your group benefits plan (which we highly discourage for business owners) and you pay yourself by dividend only, you may want to explore a private LTD policy.
- Employee Benefits? If you only take dividends from your business and have a group benefits plan, this may pose a problem with Canada Revenue Agency. CRA deems, an employment relationship exists between an employee and company by way of T4 income. If a business owner only takes dividends as a form of compensation, CRA may deem that there is no employment relationship. Employee benefits are an expense item for a business and a non-taxable benefit for employees. CRA may see this now as a taxable benefit to the business owner. The benefits provider may also deem the business owner ineligible for the group benefits plan.
- Refundable Dividend Tax On Hand (RDTOH)? This is the tax that a corporation pays on passive income (i.e. Interest, investment income, capital gains). This tax rate is at the highest rate to corporations (approximately 46%). Because CRA doesn’t double tax, this RDTOH is a credit that can be accessed by a shareholder only if a dividend is issued. If your business has a lot of passive income and makes additional income in investments, capital gains or interest, you may want to understand how to access your RDTOH dividend credit.
- Your Age, Age of the Business? Depending upon a business owners age, age of the business and financial wherewithal of the business may determine whether a business owner chooses to take a salary or dividend. You often see in the early stages of a business the owner taking more dividend than salary. As the business becomes more sustainable, the tendency is to gravitate towards a higher salary.
Of course, there are other effective ways to reduce your corporate and personal tax burden. Still, careful consultation with your Wealth Strategy Advisor and Tax Professional would be highly encouraged before undertaking such strategies. Beyond the $155,000 salary range, there are more cost and tax-effective ways of getting money out of your business.
Chris Coulter is the Founder and President of The Finish Line Group. He works with business owners to leverage their businesses to increase their wealth, reduce corporate and personal taxes, create viable succession strategies, enable employee retention strategies and allow them to exit their businesses on their terms.
Chris’ passion for what he does evolve from the mistakes he made in his first business; by not diversifying his risk and not utilizing a lot of the opportunities within his business to create significant wealth. Chris found out the difficult way and now educates business owners on how to avoid many of his former oversights and ultimately control where their finish line ends.