When you start a business, you need to decide should you go for incorporation. Should you incorporate, you need to pick paying yourself either in dividends or salary. Each has its own set of advantages and disadvantages. Here is a look at the two options.
Should you pay yourself a salary?
Paying yourself salary means that you have to pay a higher tax rate than dividends, which is why most people prefer avoiding it. However, paying yourself a salary has many benefits. When you pay yourself a salary, this is considered an Earned Income in Canada. This eventually proves to be helpful for retirement, helping you save for voluntary RRSP and involuntary CPP.
The more you earn, the more your RRSP room. In retirement, you get to dip more into the retirement pension pool, as you continued to pay your CPP premiums. You can even lower your personal income taxes by having your spouse or child as an employee and using an income-splitting strategy. BUT be careful of Tax on split income also known as TOSI rules.
The cash flow is an important factor that helps determine whether you should pay yourself a salary. However, the entire process may seem a bit cumbersome, and you will need the assistance of a professional accountant in Canada or a talented bookkeeper. They can help you to set up the payroll account with Canada Revenue Agency if you undergo the payroll access for paying yourself a salary, as well as calculating source deductions, preparation of T4 slips and more.
If you have retirement plans, it is better that you pay yourself a salary.
Should you pay yourself in dividends?
Canadian tax system integrates personal and corporate taxes in a way that individuals are taxed for the income driving from corporations which is taxed ta lower tax rates. Since you do not have to pay CPP premiums, you save significantly. Plus, there is not much paperwork involved here – which makes choosing dividends a more flexible option.
That being said, retirement pension and CPP is something you need to consider, should you choose the dividend as an option. If you are looking to maximize your CPP and RRSP entitlements, paying dividends is not the answer.
Dividends are more important after retirement, and they tend to have a higher cash flow for the business sector. That being said, paying yourself in dividends can get extremely tough as you may not get the opportunity to apply for non-business credits, especially mortgage. Dividends don’t make a part for your salary calculations; therefore, you may have problems with loan applications.
What should you choose?
Choosing whether you should opt for dividends or salary depends on different factors, and the tax rate definitely remains at the top. Also, every year, you need to get your accounts reviewed and pass a director’s resolution to pay the dividends. Usually your professional corporate tax accountant in Canada will automatically file T5 at the end of year while doing corporation income tax return. Your corporate accountant will also, often, take care of T4 filings if you are paying yourself salaries.
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