Salary Vs Dividends: Which One is Better?

Salary vs Dividends: Which One is Better? This is one of the most searched questions on Google and honestly, there’s no option that’s better, it depends. Probably not the answer you are looking for and it differs between people to people. Some prefer salary, others prefer dividends or some may prefer a combination.

A related question that is searched quite often too is ‘which option pays to least tax?’ and the answer in this case is the same as above, it depends.

This question will come up if you have ownership in a corporation since there is a choice available, as opposed to Sole Proprietorship or Partnership. I’ll try to explain this in human language, something that you can understand, along with some examples.

Let’s get started!

Basics

I will assume that you already know what salary or dividends are since you are reading this blog so I won’t go into this.

Integration

This concept is not new and it’s been around for a while. There are 2 levels of tax that you might go through: corporate and personal tax. Integration just says that whichever method of receiving compensation you go with, it’s designed so that you are paying the same percentage of tax.

The real question becomes when you are paying this tax and we will cover that more below.

Quick Accounting Lesson

Salary is considered a business expense that you can deduct against your corporation’s income. Think salary expense. Your corporation will be able to pay a lower tax with this.

Dividends are considered a distribution of the retained value of the corporation and are not considered a business expense. It is offset against the equity. Your corporation won’t be able to pay a lower tax since this is not considered an expense.

Types of Dividends

There are 3 type of dividends that we will briefly define:

•  Eligible dividend – dividends paid from a corporation that pays tax at the higher rate (General Rate), taxed more favourably on a personal level (eg. Active business income > $500k)

• Non-eligible dividend – dividends paid from a corporation that pays tax at the lower rate (Lower Rate), taxed less favourably on a personal level (eg. Active business income < $500k)

• Capital dividend – this is the other 50% of the capital gain that is not taxed and can be distributed on a tax-free basis

 For tax purposes:

• Eligible dividends are tracked in the General Rate Income Pool (GRIP)

• Non-eligible dividends are tracked in the Lower Rate Income Pool (LRIP)

• Capital dividends are tracked in the Capital Dividend Account (CDA)

The GRIP, LRIP and CDA accounts aren’t real accounts, you can’t deposit or withdraw funds from it. Instead, these accounts are solely for tax purposes and are used to track how much dividends you can distribute out of each category.

Example

In Canada, there are both federal and provincial tax rates where the provincial rates are different depending on which province you’re in. It’s also based on graduated tax rates (think stairs and each step up has a different tax rate based on income level). To make this example as simple as possible, we will assume that there are no graduated tax rates.

Compensation: $100,000

Active Business Income: $300,000

Corporate capital gain: $0

Tax Year: 2022

Province: Ontario

Assume: no payroll tax on salary to make it straight forward

Table to show tax calculation of salary vs dividends

What do the numbers in the table above mean? If you paid a salary to yourself, the business’ after-tax profit is $175,600 while if you paid a dividend to yourself, the business’ after-tax profit is $263,400. Your business can retain an extra $87,800 if you paid a dividend to yourself.

With a salary, your after-tax take home pay is $62,840 and with a non-eligible dividend, your after-tax take home pay is $71,085.

The total tax paid between corporate and personal in the first scenario is $61,560 while in the second scenario, it is $65,515.

So which one is better?

The concept of integration comes into play when you receive the funds personally, regardless if you receive a salary or dividends. The question becomes: ‘when do you want to receive the funds personally?’ If you take a salary, the corporation has to withhold all payroll taxes before you get the net amount

Situations where salary may be better:

• You would like to contribute to CPP or your RRSP account

• You would like to keep your active business income under $500k to take advantage of the lower corporate tax rates

• You need to show earned income for the purposes of getting a loan

Situations where dividends may be better:

• You want to retain the funds in your corporation to reinvest

• You want to avoid paying and reporting any payroll withholding taxes and burdens

• You would like an easier payment process (since it can just be a transfer of cash)

A key question to ask yourself is: ‘Do you need to use the funds right away?’ If yes, it doesn’t matter which option you take since integration kicks in. If no, then you don’t need to transfer the funds to your personal account right away and you can defer your taxes.

It’s important to note that integration works in theory but everyone’s situation is different and it differs based on where you’re located. It’s best to consult a professional for the most advantageous option for you.

Your Turn

Do you pay yourself a salary? Or dividends? Or a combination? Or do you need help in identifying what would be the ideal option? If the latter is your situation, it’s time to look for a solution that can help you bridge the gap. Make sure to reach out to a professional who can guide you.

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At JTL CPA, we are Ontario’s virtual accounting firm. Our goal is to automate your accounting and bookkeeping processes in a way that increases financial visibility. Pair that with our value-added approach and tailored advisory solutions gives you the ability to make sound decisions from good data. Check out our website here: www.jtlaccounting.com. 

Thank you for making it to the end of the blog post. If there are topics that you would like to learn more about in the future, please let us know down in the comments.

Until then, see you next time!

#accounting #tax #business #entrepreneurship #success