Some business experts encourage business owners to pay themselves dividends from their companies as opposed to taking a salary. But why?
This can be beneficial for some people, especially those who earn lower incomes and expect that level of income to continue. However, it’s not always the best option for everyone — there are pros and cons to each approach.
We’ll let you know about salary vs dividend and which one is better for your condition.
The Pros and Cons of Salary
Pros of salary:
- Tax deduction: Business owners can deduct salary expenses, reducing the amount they have to pay in taxes.
- CPP contributions: Employers and employees are obligated to make contributions to Canada Pension Plan (CPP), which will provide income for employees during retirement.
- Income stability: A regular salary provides stability and predictability for employees when budgeting and planning.
- You get honest income clarification on your resume. Thus, people know your actual rate.
Cons of salary:
- Higher tax rate: With a salary, employees will face a higher tax rate than if they received dividends instead. Furthermore, businesses with multiple employees would have to shoulder more costs from CPP contributions.
- Not flexible: Once the agreed-upon salary amount is set, it can be difficult to adjust it further in line with the financial needs of the business.
The Pros and Cons of Dividends
Pros of dividends:
- Dividends are taxed at a lower rate than salary. In other words, if you receive $100 in dividends, you’ll pay less tax on them than if they were your salary.
- They can be taken out of the corporation tax-free. There is no withholding tax charged on dividend payments in Canada – instead, it’s up to you to report them as income on your personal tax return and pay any applicable taxes due. If you have retained earnings (i.e., money left over after the company has paid all other expenses) that aren’t needed for business purposes, they can also be distributed as dividends rather than kept within the company’s retained earnings account or used for other investments or capital expenditures (for example, property purchases).
- Dividends can be used to pay for personal expenses without paying taxes on those amounts – though some restrictions may apply depending on how much money has been withdrawn from a corporation’s bank account over time; this amount is called “deemed disposition” and could impact when these funds will become taxable again (if ever).
Cons of dividends:
- Additional rules will likely apply depending upon whether those transfers take place online or by cheque/paperwork sent through mail; this means there may be restrictions around how often such transactions occur per year based upon what sort of paperwork needs signing across both parties involved prior authorization before closing out each transaction.”
- There are also some drawbacks associated with having more control over corporate decisions made by management teams who want their share options vested quickly while employees prefer longer-term incentive plans.
A Strategy for Self-Employed and Business Canadians
- Dividends: If you’re self-employed, you can choose to take dividends from your company. That way, the profit appears on your personal tax return instead of the corporate one.
- Salary: You can also get paid a regular salary from your corporation as an employee. This will reduce your tax bill because employees have lower income tax rates than owners do (and in some cases, no taxes at all). The downside is that you’ll lose out on any potential growth in value if profits are reinvested back into the company rather than being distributed as dividends or salary payments.
- A combination of both: Finally, there’s another option where you might be able to reduce your overall tax bill by taking a combination of salary and dividend payments from your corporation—and it’s called “salary overhang,” which is when shareholders receive more money through salaries than they actually need for living expenses so that they can save on taxes each year without reducing their daily quality of life too much
Final Thoughts
If you are running a business, it’s important to know what you’ll need in the way of cash flow. You have many options for accessing money from a corporation, but each comes with its own set of pros and cons.
For example, taking a salary is often more tax efficient than withdrawing funds as dividends—but also involves paying income tax on that income sooner than if it were taken out as dividends instead.
If you’re planning on withdrawing your earnings as dividends, then you should make sure that those dividends are taxed at only half of what they would be otherwise!
