This is one of the most common questions that I’ll receive from my owner-managed business clients.  There isn’t a blanket answer that I can give every client.  Mainly because every client’s business is different and every client is different. 

Quick Overview of Each Type of Receipt of Payment

Salary 

This is what you receive if you are an employee of the company.  You generally receive a salary payment bi-weekly or semi-monthly from your employer.  Depending on your salary, the amount that actually is deposited into your bank account will be less than your gross pay.  This is due to CPP/EI/income tax withholdings as well as any other company plans like employee-RRSP contributions. 

Dividends

This is an amount that is distributed to the shareholders of a company.  And the distribution is made with after-tax corporate dollars and made under the direction of the directors of the company.  No withholding taxes are made on this payment.  And in order to avoid the double-taxation of these funds, a Dividend Tax Credit accompanies this payment and is applied when the shareholder files their personal tax return. 

How to Decide Between a Salary and Dividends

It really comes down to personal preference of the owner.  Sometimes the decision is based on cash flow, other times it is determined due to long-term goals.  When you are trying to figure out what is best for you, here are some things that will factor into the alternatives that I’ll pull together for my clients.

1. Does the company have Retained Earnings to support the payment of a dividend?
   • If the company is operating at a deficit, then a Dividend payment isn’t possible.
   • If the company does have Accumulated Retained Earnings, what does the share structure look like?
     • Can dividends be paid?  If so, to whom?  Some classes of shares can’t distribute dividends.  So double-check that you can do this.
2. Is the main goal to minimize taxes?
   • If so, generally paying out dividends to the owner-manager is the most tax-efficient way to distribute funds to the owner.
     • But due to the new-ish Tax on Split-Income rules, it’s important to make sure that the owner-manager meets the criteria to receive dividends at a fair tax rate.
3. Does the owner-manager want to receive their Canada Pension Plan in the future?
   • If so, then a salary will need to be paid out each year. 
   • The maximum pensionable earnings for the CPP is $64,900 for 2022. 
     • This means that your CPP contributions for the year will be maximized at a salary of $64,900. 
     • If the business can handle a salary beyond this amount for the owner-manager, my recommendation is generally to pay a salary of $64,900, and then the rest should be distributed as dividends (assuming that the company has Retained Earnings to distribute)
4. Is the owner-manager comfortable with saving money throughout the year to pay for their personal income taxes if they receive only dividends during a year?
   • If the answer is no, then maybe dividends aren’t the way to go. 
     • Since there aren’t any withholding taxes on dividends it can be a bit of a rude awakening for a client to have to pay taxes in April if they are used to only earning a salary, where withholding taxes are made throughout the year. 
5. Does the owner-manager want to make RRSP contributions in the coming years?
   • If the answer is yes, unless they have a lot of unused RRSP contribution room, they will need to continue receiving a salary in some form as they will need earned income in order to create an RRSP contribution room.
     • Salary = earned income
     • Dividends = passive income and therefore not eligible for creating RRSP contribution room
6. Does the owner-manager have a health spending account?
   • If the answer is yes, they will need to receive a salary in order to avoid a shareholder benefit on the amount. 

This is just a general framework of what goes into determining what is best for each client.  From the information gathered, different scenarios can be produced to show what the impact will be on the company and personally from a cash-flow and tax standpoint. 

So while it may seem like the answer should be straightforward and simple, it isn’t.  And as an owner-manager, your goals may change after a year or two and that’s ok.  Make sure that whatever mix you come up with now, still fits your goals in the future.  You can always revise things. 

Best,

Dayna Holland, CPA, CA (she/her)

CEO of Dayna Holland Ltd.

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Are you a small business owner or self-employed and want to get ahead of the 2021 tax filing season? Be sure to check out this blog post for my top three tips.

Click here to learn more about Dayna Holland, CPA, CA.