Is it better to pay yourself a salary or dividends?

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Prudent use of dividends can lower employment tax bills. By paying yourself a reasonable salary (even if at the low-end of reasonable) and paying dividends at regular intervals over the year, you can greatly reduce your chances of being questioned.
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As a business owner, you have the option of paying yourself in dividends or as a salary. The ideal solution for you will depend on the specifics of your situation as both have benefits and drawbacks. This essay will examine the distinctions between the two, the tax ramifications, and how to minimize your tax burden.

Let’s define the terminology first. A salary is a fixed sum of money that is regularly paid to an employee, usually weekly or monthly. Payroll deductions for things like income tax, employment insurance, and payments to the Canada Pension Plan are made from salaries.

Dividends, on the other hand, are payments paid from the company’s profits after taxes to its shareholders. Payroll deductions are not applicable to dividends, however they are subject to personal taxation.

The decision between a wage and dividends will rely on your unique situation. Paying yourself a salary might be preferable if you’re just starting out and your business isn’t making much money. This is due to the fact that you can reduce the amount of taxes you owe by deducting your pay from your business’s income.

Paying yourself dividends might be preferable, though, if your company is making a sizable amount of profit. This is due to the fact that dividends are taxed less heavily than salaries. Federal tax rates on qualifying dividends are 15.02% in 2021, while those on salary might reach 33%.

It’s crucial to remember that dividends are not covered by the Canada Pension Plan, so you might be better off paying yourself a wage if you intend to rely on CPP in retirement.

So, how do you prevent overpaying taxes on your dividends? Incorporating your company is one choice. When you incorporate, you become a stakeholder in the business and are then eligible to receive dividends and pay yourself a salary. By doing this, you can continue to make CPP contributions while still benefiting from the lower tax rate on dividends.

Adding money to a Tax-Free Savings Account (TFSA) or a Registered Retirement Savings Plan (RRSP) is an additional choice. You can earn income that is tax-free or tax-deferred by doing this, which will lower the amount of tax you have to pay on your dividends.

In conclusion, it depends on your specific situation whether you should pay yourself a salary or dividends. Paying yourself a salary may be preferable if you’re just getting started, while dividend payments may be preferable if your business is making large profits. It’s crucial to speak with a tax expert to figure out the best course of action for your unique circumstances.

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