The Pros and Cons of Salaries

Today’s blog is the second of a two part series on paying yourself as a Small Business Owner — should you pay yourself a salary or in dividends?

In part one of this two-part blog, I examined the benefits and drawbacks of compensating yourself with a salary; this second analysis will provide a breakdown of dividends. Click here to read part one!

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So what are the ins-and-outs when, as a small business owner, you decide to pay yourself via dividend?  Here are some of the pro’s:

It’s simple: when you need money, just write yourself a cheque.  There are no source deductions to make and no reports to send to the government.

Lowest tax in the short term: with dividends, you do not pay into the Canadian Pension Plan (CPP). CPP contributions in 2017 are $2,564 for the employee and an additional $2,564 matched by your employer (i.e. your company), so your annual tax savings here is $5,128…a nice little weekend get away!

Depending on how you think about CPP, this can be a good thing or a bad thing. Generally speaking, if you don’t pay into the CPP program, you don’t get any pay outs once you retire. Some folks think that CPP won’t be around when they retire in 30 years, so they don’t want to pay into it.  Our opinion is that CPP is here to stay and provides a good safety net if your business unexpectedly fails.  Paying $5,128 per year into an investment portfolio for 45 years (the average working life of a person) and then being entitled to receive roughly $1,200 per month until you pass away is a very reasonable return on your investment.  Are you sure that you can do better than this investing the money yourself?  Not paying CCP premiums is the primary reason that the tax rate differs between salaries and dividends.  When CPP is ignored, the tax rate is nearly equivalent between salaries vs. dividends.

You can pay inactive persons: income splitting is a powerful tax management strategy.  Currently, you can pay shareholders (i.e. your spouse, your brother, anyone that owns shares in your company) a dividend even if they don’t provide any services to your company.  This allows you to direct income to lower income earning people and save a significant amount of tax.  Note, our liberal government is currently working to end this benefit.

Flexibility: we can easily change how much income we declare to you by having you repay any excess monies you withdrew from the company.  This can be helpful to manage your income tax rate in any given year.

There is always a downside. Here are some of the cons associated with dividends:

Surprise tax bills: depending on how much you withdraw from the company, you may have a tax bill the following April.  Your taxes could be as little as 0% or as high as 50%…it all depends on how much you withdraw.  MAKE SURE you talk with a qualified accountant before withdrawing more than $50,000 from your business.  Clients and accountants both hate surprise tax bills.

RRSP’s: you will not have access to the RRSP program.  RRSP’s are super important…in our opinion they are one of the best tax deductions available. We wrote a whole blog just on them for that reason (read it here).

Higher tax rate in the long term: generally speaking, you will end up paying more tax in the long run if you utilize dividends consistently over your lifetime, primarily due to the RRSP component described above. Please note that this depends on your personal tax circumstances and is not a universal truth.

Summing it all up, we generally take a mixed approach to the salary vs. dividend question.  This way we get the benefits from both salaries and dividends, while minimizing the downside.  While we would love to give you some specific instructions here, the “right” answer for you really depends on how much money you’re going to need over the long term from your business. Are you wondering what the best combination is for you? We offer everyone a free hour to discuss any questions that you may have. Contact us here.

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Disclaimer: Tax and legal rules change frequently and can depend on your individual circumstances. The above is not to be relied upon as legal nor tax advice and is meant for information purposes only. Please consult a legal and/or tax professional.