How to pay yourself what you’re worth
You’re the owner of an incorporated business and you want to be adequately compensated for your work while sustaining and growing the financial health of your business. You could choose to pay yourself a salary (including bonuses), pay yourself through dividends from shares you own in the company, or pay yourself through a combination of salary and dividends.
Which is best for you?
SALARY:
• Is a deduction to your company but it will also attract both employer and employee Canada Pension Plan (CPP) premiums and, in some provinces, payroll taxes.
• Generates Registered Retirement Savings Plan (RRSP) contribution room, CPP benefits and is necessary if you wish to establish an Individual Pension Plan (IPP).
• Often recommended if the cash need is immediate
DIVIDENDS:
• Are paid out of after-tax corporate profits. Corporate business income in excess of the small business deduction (SBD) limit ($500,000 federally and in most provinces) is subject to higher corporate tax rates. Most dividends paid out of dollars taxed above the SBD are eligible for more advantageous personal tax rate, referred to as eligible dividends. Dividends paid with dollars taxed at the lower SBD rate are non-eligible dividends, resulting in a lower Dividend Tax Credit for the shareholder and, consequently, attracting more personal tax than an eligible dividend.
• Generally recommended if cash is not required immediately, or if the combined corporate taxes plus personal income taxes on the dividend are less than the taxes payable on an equivalent salary.
A MIX OF SALARY AND DIVIDENDS:
• In the past, tax professionals usually advised business owners to pay themselves at least enough salary to reduce corporate profits below the SBD limit, to avoid higher rates of corporate tax on active income. But with the increase in personal tax rates, more tax can now be deferred by leaving income in the corporation. So, if your personal finances allow it, it can make sense to retain high tax rate income inside the corporation for investment back in the business or other investment opportunities, subject to the new Passive Investment Rules that may limit future SBD limits for the corporation. However, to the extent that you require cash on a regular basis, salary is still the preferred compensation choice until corporate income is reduced to the SBD limit.
PURE DIVIDEND STRATEGY:
• Taking compensation solely as dividends means that you will not be able to contribute to investments held in an RRSP, and will lose access to CPP disability benefits and may not qualify for group disability plans. However, this strategy can allow more income to be saved inside the corporation than could otherwise be contributed to investments held personally within a RRSP or to an IPP, and could potentially offset the reduction in future CPP retirement benefits. But this is a complicated strategy that requires consultation with your professional advisors.
Compensation planning is closely linked to retirement planning. Your professional advisor can help make the best choices for you.
Jeff Somers, BA, RRC, CFP, works at Investors Group in Charlottetown. This column is written and published by IG Wealth Management as a general source of information only. It is not intended as a solicitation to buy or sell specific investments or to provide tax, legal or investment advice. Contact your own adviser for specific advice about your circumstances.