Salary vs. Dividends for Canadian Business Owners

How salary works

Salary (or bonus) is paid through payroll like any other employee's wages. The corporation deducts the salary as an expense, which lowers its taxable income. You pay personal income tax on it, and the company must withhold and remit income tax, Canada Pension Plan (CPP) contributions and, in some cases, EI premiums, and issue you a T4.

Advantages of salary

• Creates RRSP contribution room. Salary counts as earned income; dividends do not.
• Builds CPP entitlement. You contribute both the employee and employer share, which funds a future CPP retirement pension.
• Supports a clear income record. Lenders reviewing a mortgage application often find a steady T4 income easier to work with.
• Can qualify for child care expense deductions and other benefits tied to earned income.

Trade-offs

• Payroll accounts, remittances and slips add administration.
• CPP contributions are a real cost today, even though they fund a future benefit.

How dividends work

Dividends are paid from the corporation's after-tax profits. The corporation does not deduct them. You report them personally and receive a dividend tax credit, which recognizes that the corporation has already paid tax on that income. Dividends paid by most small businesses taxed at the small business rate are "non-eligible" dividends, which have a different gross-up and credit than "eligible" dividends paid from income taxed at the general rate.

Advantages of dividends

• Simpler administration. No payroll account or monthly remittances; dividends are declared by resolution and reported on a T5 slip.
• No CPP contributions, which improves short-term cash flow.
• Flexible timing. Dividends can often be declared when cash is available.

Trade-offs

• No RRSP room is created.
• No CPP pension is built, so retirement savings must come from elsewhere.
• Tax on split income (TOSI) rules can tax dividends paid to family members at the top rate unless an exclusion applies.

Why the totals are often close: integration

Canada's tax system is built on a principle called integration. In theory, earning income through a corporation and paying it out should cost about the same total tax as earning it personally. In practice, integration isn't perfect. Depending on the province, income level and type of income, salary or dividends may come out slightly ahead in a given year. That's why the decision should be modelled for your actual numbers instead of relying on a general rule.

Other factors that shift the answer

• Your personal income needs. Leaving profits in the corporation can defer personal tax, but only if you don't need the cash now.
• Retirement plans. Some owners want RRSP room and CPP; others prefer to invest inside the corporation. Large passive investment income inside a corporation can reduce access to the small business deduction, so the two decisions are linked.
• Family members. Paying salary to a family member requires that they actually work in the business and are paid a reasonable amount. Dividends to family members are subject to the TOSI rules.
• Government benefits. Your personal income level can affect benefits such as the Canada Child Benefit and, later, Old Age Security.
• The corporation's income level. Salary reduces corporate taxable income, which can help keep a business within its small business deduction limit.
• Timing. A bonus declared at year-end but paid later must be paid within 180 days of year-end to be deductible in that year.

A mix is common

Many owner-managers use a blend: enough salary to create the RRSP room and CPP coverage they want, with dividends on top for flexibility. The right mix for a given year depends on the corporation's profit, your family's cash needs and your longer-term plans. These are the kinds of questions tax planning should answer before your corporation's year-end, not after.

Common questions

This article is general information only and is not tax or accounting advice for your specific situation. Tax rates, CPP and RRSP limits change annually; refer to the Canada Revenue Agency for current figures.