As a small business owner in Canada, one of the most critical decisions you'll face is how to pay yourself. The choice between drawing a salary, receiving dividends, or a combination of both has far-reaching implications for your personal and business finances. This comprehensive guide will explore the benefits and drawbacks of each option, helping you make an informed decision that aligns with your financial goals and business strategy.

Understanding Salary Payments: A Strategic Approach

Benefits of Salary:

  • CPP Contributions: Paying yourself a salary allows you to contribute to the Canada Pension Plan (CPP), creating a foundation for a secure retirement plan.

  • Corporate Tax Deduction: Your salary or bonus counts as a corporate expense, effectively reducing your business’s taxable income.

  • Income Splitting: Salary payments facilitate income splitting with family members, potentially lowering the overall tax burden.

  • Retirement Planning: Salaries enable contributions to a Registered Retirement Savings Plan (RRSP) or a Tax-Free Savings Account (TFSA), offering additional avenues for retirement savings.

Drawbacks of Salary:

  • Taxability: Salary is fully taxable at your personal income tax rate.

  • CPP Double Contributions: As both the employer and employee, you’ll be responsible for both portions of the CPP contributions.

  • Administrative Requirements: Being on the payroll requires setting up and maintaining a payroll account with the CRA, which can be administratively burdensome, especially for solo entrepreneurs.

The Dividend Route: Flexibility and Tax Efficiency

Advantages of Dividends:

  • Lower Tax Rate: Dividends often enjoy a lower tax rate compared to salary, which can be advantageous in certain tax brackets.

  • Flexibility in Disbursement: You can declare dividends at your convenience, offering greater control over personal and corporate cash flow.

  • CPP Savings: Opting for dividends means you're not required to make CPP contributions, enhancing your immediate cash flow.

  • Simplicity: The process of paying dividends is straightforward – a check from the corporation to yourself, accompanied by updates to the Minute Book and a director’s resolution.

Disadvantages of Dividends:

  • Reduced CPP Benefits: Not contributing to the CPP can significantly impact your retirement benefits.

  • RRSP Limitations: Receiving dividends means you can't contribute to an RRSP.

  • Limited Tax Deductions: Choosing dividends may restrict your ability to claim certain income tax deductions, such as child care expenses.

  • Retirement Planning Challenges: Without structured retirement plans like CPP and RRSP, you’ll need a disciplined approach to saving for retirement.

  • Credit Considerations: Dividends are often not recognized as income for credit applications, like mortgages or lines of credit, which could affect your borrowing potential.

Combining Salary and Dividends: Balancing the Best of Both Worlds

In Canada, with the small business earnings limit set at $500,000, strategically choosing between salary, dividends, or a combination of the two can keep your corporate taxes within the lower bracket. This blended approach allows you to tailor your compensation to meet various needs:

  • Personal and Corporate Cash Flow: Balancing salary and dividends can optimize both personal and corporate cash flow needs.

  • Tax Planning: A combination allows for more nuanced tax planning, potentially reducing your overall tax liability.

  • Retirement Strategy: Mixing salary and dividends can provide the benefits of CPP contributions and the tax efficiency of dividends.

  • Flexibility: This approach offers the flexibility to adjust your compensation strategy as your business and personal financial situations evolve.

Making the Right Choice: The Role of Professional Advice

Deciding between salary and dividends requires careful consideration of numerous factors, including your current income, future financial needs, corporate earnings, personal cash requirements, and age. Engaging with a legal advisor and accountant can provide invaluable insights, helping you navigate the complexities of this decision.

Capex CPA: Your Partner in Financial Decision-Making

At Capex CPA, we have a wealth of experience in advising startups, small businesses, and growing enterprises on compensation strategies. Our team can offer expert guidance tailored to your unique situation, assisting you in making a choice that supports both your short-term needs and long-term aspirations. Contact us to schedule a consultation and explore how different compensation options can impact your business and personal finances now and in the future.