If your business is incorporated, you are faced with the classic choice faced by any shareholder/owner: should I pay myself a salary or dividends? Both methods have advantages and inconveniences and the correct answer is usually a combination of both. Take a look at the benefits of paying yourself in dividend form.
What Is a Dividend?
A dividend is a right that is attached to the fact that you own shares in the company. You don’t even have to work for the company at all to receive a dividend. All you need to do is own the shares. In contrast, a salary is related to actual work that you put in to the company. As such, dividends can be declared how and when you see fit, pursuant to certain cash flow accounting tests. Dividends can be paid regularly or irregularly, at your discretion. As such, some planning is possible. For example, you could choose to pay a dividend on January 1 rather than the previous December 31. In doing this, you would be deferring your personal taxes on the dividend by a full year.
Tax Treatment of Dividends
In theory, income earned through a company and paid out as a dividend is taxed at about the same rate as income paid as a salary to the owner. This fiscal theory, known as the integration mechanism, works well on paper, but not always in practice. Depending on the province where you reside, on your personal tax rate, on the type of income earned by your company and on the company’s tax rate, there may be a real difference in practice. Before making a decision, sit down with your tax adviser and run some simulations to see what works best for your specific case. Dividends, unlike salaries, are not subject to the payment of Canada Pension Plan contributions, employment Insurance contributions and other provincial payroll taxes. These amounts can have a significant impact on how much is left in your pocket at the end of the day and must be taken into consideration.
Tax Planning Using Dividends
Dividends can be a useful tool when planning for your personal and business taxes. Other than the deferral mentioned above, new businesses can take advantage of an interesting two-year deferral. New companies can lend funds interest free to their shareholders for two years. For new companies, after two years, the amounts are deemed to be dividends. This means that you can defer payment of your taxes for that period, helping with cash flow early on in the business. However, make sure you set aside money to pay the taxes at the end of year two, because the bill might be quite high. Other more complex planning can allow you to split your dividend income with members of your family through family trusts or shares with discretionary dividends. These useful structures are complex and should not be put in place without professional advice. As always, there is no single correct answer when determining if a salary or a dividend is the best way to pay yourself. Every case must be looked at on its own merits, but it is worth putting in the effort early on to avoid paying unnecessary taxes.