Salary vs Dividend

I have been often asked what's the difference between salary and a dividend. Although, each have their own characteristics and tax involvement, at the end of the day it's up to the decision makers to take on a salary or a dividend. it's a choice and not an obligation, unless it's part of agreement between shareholders, but in general, it will be a choice.

First, I have to explain that a salary or a dividend comes from a incorporated company. It's funds transferred from the incorporated business to the owner. If the business is not incorporated, the owner of the company is taxed on business income and not a salary or a dividend.

THE IMPACT ON THE COMPANY

First, let's discuss the salary. When a salary is paid, the salary and the employer's portion of the payroll benefits reduces the business income.

As an example, to keep this simple, let's say the total revenue for the entire year is $10,000. You would like to pay your self a salary/bonus of $6,000. On that $6,000 the company will pay $334.33 of his share of the CPP. Therefore, the total earning before tax will be $3,665.67. Taxes are about 13%, so a total of $476.51 is paid in taxes leaving a net income of $3,189.16

TOTAL CORPORATE INCOME TAX PAID = $476.51

Unfortunately, when a company pays out a salary, it has to withhold payroll deductions right away on behalf of the employee. So when the company pays out the salary of $6,000.00, the owner will receive $3,853.88 where as $2,146.12 will be withheld and paid right away to the Canada Revenue Agency (CRA).

In terms of cashflow, the total payments made to CRA in payroll deduction and taxes will $2,956.96.

TOTAL PAYMENTS MADE TO GOUVERNMENT AGENCY = $2,956.96

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On the other hand a dividend is much simpler, but you have to be careful as a dividend is paid out after corporate taxes. As an example, let's say your company made a revenue of $10,000 for the entire year and would like to pay out a dividend of $6,000. First the company has to tax itself on the whole $10,000, whatever is left after tax can be distributed to shareholder. So in this example, the income after tax will be $8,700 giving the shareholder the ability to pay himself a dividend of $8,700 if he wishes to, but in this case of our example, the shareholder has made the decision to pay himself a dividend of $6,000.

When the dividend is payed out to the recipient, the recipient will receive the entire $6,000 as there is nothing to withhold on a dividend. The recipient is liable to pay tax installments if he wishes to.

TOTAL CORPORATE INCOME TAX PAID = $1,300

In sum, the choice will be to pay out payroll deductions right away, or wait until the shareholder does his income tax to pay the taxes. what ever will be the choice, it will all be about the company's ability to pay CRA right away or the owner to differ the taxes to when he declares his income in his tax return.

THE IMPACT ON THE SHAREHOLDER

We've discuss the impact on the company now let's see what happens when a shareholder prepares his tax return.

If the shareholder selects a salary, the shareholder will be taxed on the $6,000. Then he will receive an income tax credit of 334.33.

To illustrate the impact:

Because the employer withheld $1,811.79 of taxes on the $6,000 the shareholder will receive a tax refund of $961.94 ($849.85 - 1,811.79)

On the other hand, the dividend is totally different. The shareholder has withdrawn $6,000 of dividend, right? Well he will be taxed on $6,900 and not $6,000 as a dividend has a gross up and it's on that gross up the shareholder is taxed on. To compensate for the gross up, the recipient will have the right to a tax credit of 9.0301%.

To illustrate the impact:

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COMPARISON

If we compare a salary in the hand of the shareholder, he will receive $961.94 in refund but he had to pay $2,146.12 right away when the salary was declared ($1,811.79 + $334.33).

SALARY: $6,000 - $2,146.12 payroll deductions + $961.94 refund = $4,815.82

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Now if the shareholder paid himself a dividend, here is how much he would have in his pocket:

DIVIDEND: $6,000 - $411.92 tax payable = $5,588.08

As you can see there are benefits to pay out a salary and there are benefits to pay out a dividend. What ever you decide to do will be up to you. What you have to keep in mind is the cashflow of the company when paying out the salary or dividend.