Both have advantages and disadvantages associated with them so let’s take a look.
If you take a salary from the corporation, the corporation will be able to deduct this amount from its income.
So if the corporation earns $50,000 and you take a salary of $50,000, the corporation’s net income is reduced to zero.
From your perspective, you include the salary in your personal income.
Having personal income can be advantageous for a number of reasons:
On the other hand, personal income is subject to the Canadian personal tax rates. You’ll be taxed on the full amount of whatever you take out of the corporation. In addition to the added tax, taking a salary from the corporation requires you to open a payroll account with the CRA, make remittances and submit a T4 information return. So there may be a little bit of added work involved here.
If you take a dividend from the corporation, the corporation does not get to deduct this amount from its income.
So if the corporation earns $50,000 and you take out a dividend of $50,000, you’ll still have to pay corporate tax on the full $50,000.
To compensate for this, the CRA taxes dividends at a much more favourable rate. You can essentially take out almost $50,000 of dividends without paying virtually any tax (assuming you have no other sources of income).
Taking a dividend from the corporation is also less involved than salary as you’ll just have to record it in the corporate minute book and file a T5 information return. So no need to worry about opening a payroll account or making proper deductions.
Though by taking only a dividend, you won’t have any personal income.
That means you won’t be paying into CPP, be able to increase your RRSP contribution room, or be able to deduct certain personal tax credits on your personal tax return.
Of course, you don’t have to choose between taking out your money as only salary or dividends – a combination of both may be best.
Naturally, there is no “right mix” of salary or dividends that will work for every business.
Since each person’s tax situation is unique, the right mix of salary and dividends is going to depend on a number of factors that will differ across the board.
What’s true is that by doing the right tax planning, deciding on an optimal combination of salary and dividends can save you some significant tax dollars. Talk to your tax professional to make sure you’re taking full advantage of the options available to you.
Josh is the co-founder and CEO of LiveCA.