This does not apply to the average employee, but if you have your own corporation then you have options as to how you are paying yourself from a limited company.
As a self-employed incorporated person, all of your earnings are generated by your corporation and likely taxed at favorable small business rates.
Now the cash you need to pay your personal expenses is stuck inside your corporation, thus leading to how will you pay yourself so you can buy groceries, pay your mortgage and deal with other expenses you may have.
To preface this debate, there is no right or wrong answer on this subject. The best answer is it depends, and it depends on what is right for YOU. What we want to do today is cover the pros and cons of each side, so you can make an informed decision and discuss this with your tax professional and financial planner.
Let’s first look at what happens when you pay yourself a salary.
Your salary is a tax-deductible expense to the corporation will have less net profits, and therefore you will pay less income tax.
The downside is that your corporation did not have to pay tax on that amount, which means you personally have to pay tax based on your marginal tax rates. Some of the pros of paying a salary, the corporation pays less income tax, this could also lead to lowering your corporate tax rate.
A controversial one, in which we like to view as a positive vs a negative, is your contributions to the Canada Pension Plan.
If you pay yourself a salary up to the YMPE “Yearly Maximum Pensionable Earnings”, then you have to pay the CPP premiums of 5.10% for both yourself personally and the employer side.
Although this is an extra cost, it helps build your guaranteed pension stream at retirement. You’re also helping your disability protection – if you pay yourself a salary, you have an employment income that can be replaced through disability coverage or qualify for CPP disability benefits if you are off work long term. The importance of these items is often overlooked when you are debating Salary vs Dividends.
Another pro of Salary is the creation of RRSP room.
The RRSP room might be important in your tax planning. It might be something you want to create either as a tax planning tool or a tax minimizing tool down the line. Of course, important retirement planning is key to knowing what the best savings vehicle for your future retirement is.
Finally, you’re also creating employment income which aids in the process when seeking lending from the bank. Whether you want to get a car loan or a mortgage, showing this income can be quite important in the qualifying process.
Again, the advantages are that you’re qualifying for the CPP and you’re creating a disability potential income stream. If that were to happen, you’re creating RRSP room and you’re also creating on employment income.
The disadvantages are that you’re creating taxable personal income, and you have to pay both sides of the CPP premium.
Now let’s take a look at dividends.
The big advantage is that when you pay yourself a dividend out of your corporation, you get tax advantaged income.
Dividends you pay yourself from the corporation are after tax profits of your company and you qualify for the Canadian Dividend tax credit, which equals a more favorable tax rate. As this is after tax profits, there is no reduction in taxable corporation income like a salary.
When you pay yourself dividends, you do not have to remit for CPP premiums for yourself or your corporation either. However, you are not creating RRSP contribution room or an income that potentially qualifies for disability coverage in the event of a disability.
What is the best way to pay yourself from a limited company? Well, as an entrepreneur, a business owner and incorporated person, you need to look at your own situation, and often the answer is a blended combination.