This post will provide a brief overview of the subject matter from the perspective of a small business owner and assumes the following:
- The business is incorporated and qualifies as a Canadian Controlled Private Corporation (“CCPC”)
- It operates in Ontario
- We are dealing with the 2011 taxation year
For the small business owner in Canada, there are two alternatives for distributing a company’s profit to herself:
- She can pay out the profit to herself a salary
- She can pay out the profit to herself as a dividend
- A combination of both
We wish to make this post simple and understandable, so for the sake of simplicity, we shall only demonstrate alternatives 1 and 2.
Let’s assume that the owner makes a profit of $118,343.20 before she pays herself anything. She has two alternatives: (1) she can pay it all out to herself as a salary and pay no corporate income taxes (since her net income would be reduced to $0; or (2) she can pay corporate taxes on the profit and distribute the remaining profit after taxes to herself as a dividend:
|Net income before salary||$ 118,343.20||$ 118,343.20|
|Net income before tax||118,343.20||–|
|Corporate tax payable @ 15.5%||(18,343.20)||–|
|Dividends available||$100,000.00||$ –|
As you can see, if the owner decides to remunerate herself with a dividend, she would receive $100,000 of dividend income after her company pays corporate taxes at a rate of 15.5%. This is the 2011 tax rate for the first $500,000 of net income for a CCPC in Ontario.
On the other hand, if she pays out all of her profit to herself as a salary, she would receive $118,343.20 in salary income. In this scenario, she pays no corporate income tax since her net income after she pays out her salary is $0.
Now let’s look at the personal income taxes payable on these two sources of income:
|Income to Owner||$100,000.00||$118,343.20|
|Personal income tax on dividends||(13,911.00)|
|Personal income tax on salary||(35,265.00)|
|Income after taxes:||$86,089.00||$83,078.20|
As you can see, the marginal tax rate on salary income is much higher than that of dividend income. Again, the above are personal tax rates for Ontario. But there’s one more tax that we forgot…
|Total corp. & personal taxes paid||$32,254.20||$35,265.00||$3,010.80|
|CPP payable on salary||5,226.30||5,226.30|
|Total taxes paid:||$32,254.20||$40,491.30||$8,237.10|
To summarize in the above table, the combined corporate and personal taxes paid using dividends ($32,254.20) would be lower than if she chose to pay herself with a salary ($35,265.00).
Moreover, if she paid herself a salary, she would be required to pay CPP premiums on her salary of $5,226.30. This represents the employer portion of $2,613.15 (paid by her corporation) and the employee portion of $2,613.15 (paid by her).
So the total tax she’d have to pay by choosing the salary option ($40,491.30 of corporate tax, personal tax & CPP premiums) would be $8,237.10 greater than if she chose to pay herself a dividend.
It would appear in the above (simplified) analysis that there could be some significant tax savings in choosing to pay yourself with a dividend instead of a salary. However, there are some things to be mindful of:
- You are only eligible for Canada Pension Plan benefits (upon turning 60 years old) if you paid into it in the first place. CPP premiums are only payable on salary. Therefore, by paying yourself only dividends and not contributing to the CPP, you take the risk of having insufficient retirement income if things don’t work out as planned.
- Your RRSP contribution limit is calculated as 18% of your “earned income” (up to a maximum of $22,450 for 2011). “Earned income” does not include investment income such as dividends. Therefore, if you choose to pay yourself only with dividends, you won’t be able to contribute to an RRSP to reduce your taxes payable.
This post is for information purposes only and should not be interpreted as tax advice or a legal opinion. Please consult with us to review your own particular circumstances.
© Copyright Jenny Lin, 2010.