National Post - Financial Post Magazine
Salary or dividends?
Business owners have options in paying themselves
A new year means new decisions, especially when it comes to how small business owners should be compensated for their work: salary or dividends.
A private company pays corporate income tax based on the type of income it earns. The first of active business income is eligible for the small business deduction ( This means that corporate income below this amount is initially taxed at the low small business tax rate and isn’t taxed a second time until the funds are withdrawn from the corporation by way of a “non-eligible” dividend paid to the business owner. These dividends derive their name from the fact that they are not eligible for the enhanced dividend tax credit available for corporate income taxed at the high rate, such as dividends received from public companies or dividends paid out of active business income ( above the limit, discussed below.
Changes announced to the taxation of non-eligible dividends in last year’s budget and effective for there is no longer a universal “tax rate advantage” of having funds taxed inside the company at the low SBD rates and then paying the amount out as a non-eligible dividend, either in the current year or when needed later on. In half the provinces there is now a small tax rate disadvantage and the tax rate advantage is negligible in the other five, other than Nova Scotia where it’s
That said, even in the five provinces where there is a slight tax rate disadvantage, if the funds are not needed to fund current lifestyle, it’s best to retain and invest the income in the corporation and to pay the after-tax amount out as a non-eligible dividend to the shareholder, so as to enjoy a significant tax deferral of income within the corporation. This “tax deferral advantage” ranges from a high of in Nova Scotia to a low of in Alberta. What about ABI above that is not eligible for the lower
tax rates? In all provinces there is a tax cost associated with paying ABI as an eligible dividend and, therefore, salary may be preferred if the funds are needed immediately or in the short term. It may, however, still be beneficial for a private company that earns to have it initially taxed inside the corporation at higher corporate tax rates to retain and invest the in the corporation so as to enjoy a valuable tax deferral, which can range between and depending on the province.
For a closer look at the tax rates and (dis)advantages for each province, please see my full report
available at cibc.com.