As a business owner of a corporation, you can receive income in one of two ways - salary or dividends. This decision can be a complex one but taking the time to make it will maximize your after tax position.
While in past years taking a salary or bonus was preferred, to ensure corporate income was brought down to the small business limit, 2022 corporate and personal tax rates may make dividends a better option for some.
Let’s take a look at your options:
If you receive the income as a salary (or bonus), your corporation can deduct the salary expense and applicable payroll taxes from taxable income. This will reduce the corporation's tax owing. You would then claim the salary (or bonus) as taxable income and pay personal taxes on it.
Instead of paying out a salary, you can keep the income in the corporation and instead receive dividends from the corporation’s after tax income. Once you receive the dividends, you will report the income on your tax return.
For capital dividends, you will generally pay no tax. For eligible and non-eligible dividends, you will pay a lower tax rate than you would for salary thanks to the dividend tax credit (DTC). The DTC is meant to offset the taxes paid by the corporation before distributing dividends.
Which to choose: Salary or dividends?
The decision between salary or dividends should be based on a few factors, including tax rates, personal cash flow needs and risk of income loss. For example, if you need the cash flow to cover personal costs, paying salary may be preferred, as you will have access to the funds sooner.
If you have some capital losses to use up or other income splitting strategies to consider, it might benefit you to take dividend income. You may also want to consider which will better reduce your corporate income and which will generate more after tax income.
You also want to consider your Registered Retirement Savings Plan (RRSP) contribution room.
RRSP contribution room dictates how much money you can put in your RRSP. When you put money into your RRSP, you get to deduct the income from your taxable income. When you withdraw the funds from your RRSP, usually in retirement, you should be paying a lower tax rate on the income as you will likely be in a lower tax bracket.
Maximizing your RRSP contribution room provides you with greater potential tax saving opportunities over the course of your life. To grow your contribution room, you must receive a salary or bonus. Dividends do not create additional contribution room.
If you were to receive a salary of $171,000 in 2022, you would create a contribution room of $30,780, which is the maximum amount for 2023.
If you don’t have any reason to withdraw funds, you may still want to consider withdrawing a salary to maximize RRSP TFSA (tax free savings account) contributions.
Otherwise, you may want to leave the funds in the corporation so that you can build investments in your corporation and improve your success personally and professionally with tax deferral.
It is important to stay informed on the changes in corporate and dividend tax rates to make sure you are always making the most tax efficient decision.
To find out whether you should pay yourself a salary or dividends, contact our team today. We will review your specific circumstances to help you make the best possible decision.