When you’re an incorporated professional, deciding how to pay yourself — either through salary or dividends — can significantly impact your tax liabilities, retirement savings, and long-term financial well-being. Here’s a list of the top 10 considerations to keep in mind when choosing between salary and dividends.
1.Tax Efficiency
One of the primary factors is tax efficiency. Salary is taxed at your personal marginal rate, while dividends are taxed using a gross-up and tax credit system. Dividends are often taxed at a lower rate than salary but may come with other financial trade-offs. Consider both the immediate and long-term tax implications.
2. CPP Contributions
When you pay yourself a salary, you’re required to contribute to the Canada Pension Plan (CPP), both as the employee and the employer. This builds up your retirement benefits. However, paying yourself through dividends exempts you from CPP, potentially reducing your future CPP income in retirement.
3. RRSP Contribution Room
Salary generates RRSP contribution room at 18% of your earned income, up to a yearly maximum. Dividends, on the other hand, do not generate RRSP room. If maximizing your RRSP contributions is part of your retirement planning, salary is often the preferred option.
4. Tax Deferral Opportunities
Paying yourself through dividends allows you to retain earnings in your corporation, deferring personal income tax until a later date. This can be particularly beneficial if you expect to be in a lower tax bracket in the future or want to keep more funds within the corporation for reinvestment.
5. Employment Insurance (EI) Contributions
EI contributions are optional for shareholders. If you opt into EI, salary payments are required to contribute, but you can access benefits like parental leave. Dividends are exempt from EI contributions, so if you rely on dividend payments, you won’t have access to those benefits.
6. Income Splitting
Dividends provide more flexibility for income splitting with family members. However, the Tax on Split Income (TOSI) rules have restricted this benefit, so it’s crucial to understand whether your situation qualifies for dividend-based income splitting without triggering punitive tax rates.
7. Corporate and Personal Tax Integration
Tax integration seeks to equalize the tax burden between salary and dividends. However, integration is not perfect, and in some provinces, the combined corporate and personal taxes may make one option more advantageous than the other. Review both corporate and personal tax rates in your province to optimize your decision.
8. Timing Flexibility
Dividends offer greater flexibility in timing. You can pay dividends irregularly, as needed, to manage your tax burden. In contrast, salary requires regular payments, which may not always align with cash flow fluctuations in your corporation.
9. Eligibility for Individual Pension Plans (IPP)
If you are looking for additional retirement savings options beyond the RRSP, paying yourself a salary makes you eligible for an Individual Pension Plan (IPP). This is a defined benefit pension plan designed for high-income professionals, providing an opportunity to shelter more income from taxes than an RRSP. Dividends do not allow for IPP contributions, so consider this if you aim to maximize tax-deferred retirement savings.
10. Compliance and Administration
Salary payments require more administrative work, including remitting payroll taxes and making regular source deductions. Dividends are easier to administer but must be declared in alignment with corporate earnings and shareholder agreements. Consider the administrative burden and compliance requirements for each option.
By carefully weighing these 10 factors, you can make a more informed decision on whether paying yourself through salary, dividends, or a combination of both makes the most sense for your unique financial and tax situation. Always consult with a financial advisor or tax professional to tailor these strategies to your personal goals and circumstances.
