Choosing how to pay yourself (payroll vs dividend) is confusing. Is it better to take payroll or a dividend? The answer for your company will depend on your budget, planning, and appetite for administration.
In general, payroll should be used for day-to-day living expenses and dividends should be used to clear excess retained earnings from the corporation. However, just like no two businesses are the same, no two compensation plans are the same.
Here’s some background on Payroll vs Dividends to start our conversation.
Payroll are deductible for income and become a tax deduction.
The expense reduces the corporation taxable income, thereby lowering the company tax liability.
Payroll benefits include the following:
- A steady and consistent income allows for proper budgeting for personal expenses
- Earned income means higher RRSP contribution room – 18% of earned income is added to your RRSP contribution limit
- CPP Contributions and pension – wages will allow you to contribute to the CPP, which means you will benefit in the future when you collect it.
- Fewer headaches at tax time – by the time you file your tax return, you will have already paid your income taxes and avoid any unexpected tax bills.
- Higher administrative costs
- Very rigid deadlines and penalties for non-compliance
- Need to issue T4 Statement of Renumeration Paid and balance payroll accounts
Dividends are distributions from the after-tax earnings of the company.
Dividends are considered investment income in the taxes of the receiver. Dividends are not a business expense and thus do not reduce the amount of corporate taxes paid. Dividends impose a lower personal tax liability than payroll because they come with a dividend tax credit. Some other advantages:
- Lower Costs – Dividends eliminate the need for CPP contributions, lowering corporate and personal costs.
- Simplicity – If you own 100% of the corporation, you can declare dividends and have them transferred from the corporation to your personal account.
- Less chance for payroll penalties- Payroll remittances have to be paid each month, and late payments are subject to penalties. Paying dividends eliminates the chance of late or missed remittances.
- Dividends are issued to all shareholders of the same class
- Owner needs to replace CPP retirement savings with an alternative investment
- No RRSP contribution room
- Need to issue T5 Statement of Investment Income
We’re asked all the time to advise our clients on the best strategy to take income from their corporations. When planning our compensation strategy, we consider the clients individual needs and budget, their ability to budget, and their appetite for administration. Set up a systems review with us to get some advice based on your situation.