Which is more tax-efficient for a small business owner?

As an incorporated small business owner, is paying yourself via a salary or dividends — or a combination of the two — more tax-efficient?

Which is more tax-efficient for the incorporated small business owner — paying yourself via a salary or dividends, or a combination of the two?

The answer appears to be easy and obvious — all three options should result in the same tax bill. That’s because the Canadian tax system is based on integration, a theory that says there should be zero difference between personally earned income and income earned in the corporation and paid out as dividends.

The reality is, however, integration doesn’t work perfectly in a country where personal and corporate taxes vary significantly depending on your province of residence.

And here’s another important consideration: Leaving more money in your company might also gain you more tax-advantaged money in retirement. It works like this:

Active business income that you leave in your corporation is taxed at the much-lower small business corporate tax rate.

When you take money out of your corporation as salary, the tax rules allow your company to deduct that amount as an expense and the money you receive is taxed in your hands at your marginal rate.

When you pay yourself with after-tax dividends from your corporation, your company doesn’t get a deduction for that expense and the dividends are taxed in your hands but at a lower tax rate than for a salary.

Until recently, financial planning experts often advised small business owners to take enough in salary from the corporation to maximize Registered Retirement Savings Plan (RRSP) contributions.

Recently, a new theory has gained traction — take only enough money from your corporation in dividends to pay personal living expenses, leave the rest inside your company, and reinvest those funds as you would for an RRSP.

You’ll pay tax on the dividends at a lower rate and the money left inside your corporation is taxed at the lower small business rate.

When you retire, instead of withdrawing funds from your RRSP, you can sell your corporate investments and take the after-tax amounts as dividends. Unlike RRSP contributions which must be transferred to a Registered Retirement Income Plan (RRIF) by age 71, and unlike RRIFs which require that you take specific withdrawals, dividends give you better control over when you take your savings and how much tax you will pay.

By paying yourself with dividends, your corporation is not required to make Canada Pension Plan (CPP) contributions or make EI premium or other provincial payroll deductions on your behalf. That could be a benefit or a drawback because your CPP income will be reduced at retirement.

Salary vs. dividends; corporate vs. RRSP investments — which is right for you? Before you make your decisions, talk to your professional advisers.

J. Kevin Dobbelsteyn is a certified financial planner with Investors Group Financial Services Inc. His column appears every Wednesday.

 

Get local stories you won't find anywhere else right to your inbox.
Sign up here

Just Posted

Courtenay’s Ace Brewing Company’s Jet Fuel IPA was chosen for second place in the annual Canadian Brewing Awards. Photo submitted
Courtenay brewery takes silver medal at Canadian Brewing Awards

“It’s huge - they are the biggest awards in Canada that you can get (in the brewing industry).”

Provincial health officer Dr. Bonnie Henry updates B.C.’s COVID-19 situation at the legislature, Jan. 11, 2021. (B.C. government)
Vancouver Island smashes COVID-19 high: 47 new cases in a day

Blowing past previous records, Vancouver Island is not matching B.C.s downward trend

The Comox Strathcona Regional Hospital District board is concerned about having to fund more than just hospitals like the one in the Comox Valley. Photo by Mike Chouinard
Comox Strathcona board worried over funding more than hospitals

Island Health points to seniors care to reduce demand at acute care sites

Environment Canada is forecasting snow for the east Vancouver Island region the weekend of Jan. 23. (Black Press file)
Up to 15 cm of snow forecast for Courtenay area this weekend

Snow to begin Saturday night, according to Environment Canada

Former town councillor and long-time volunteer John Marinus was presented with the Freedom of the Town in 2017 by then-Mayor Paul Ives. Facebook/Town of Comox photo
Five-term councillor, long-serving volunteer John Marinus passes away

He was presented the Freedom of the Town award in 2017

Businesses continue to struggle under COVID-19 restrictions as the pandemic reaches the one-year mark. (B.C. government)
Another 564 COVID-19 cases, mass vaccine plan coming Friday

15 more deaths, community cluster declared in Williams Lake

Cannabis bought in British Columbia (Ashley Wadhwani/Black Press Media)
Is it time to start thinking about greener ways to package cannabis?

Packaging suppliers are still figuring eco-friendly and affordable packaging options that fit the mandates of Cannabis Regulations

A specialized RCMP team is investigating a suspicious trailer, which might have connections to the illicit drug trade, found abandoned outside a Cache Creek motel. (Photo credit: <em>Journal</em> files)
Police probe U-Haul trailer linked to illicit drugs left outside Cache Creek motel

Hazardous materials found inside believed to be consistent with the production of illicit drugs

Premier John Horgan leaves the podium following his first press conference of the year as he comments on various questions from the media in the Press Gallery at B.C. Legislature in Victoria, B.C., on Monday, January 13, 2020. THE CANADIAN PRESS/Chad Hipolito
Interprovincial travel restrictions a no-go, Horgan says after reviewing legal options

The B.C. NDP government sought legal advice as concerns of travel continue

SD62 bus driver Kerry Zado said it’s common to see drivers lose their patience and pass by his bus while he’s picking up students during the morning commute. (Aaron Guillen/News Staff)
Concerned Island school bus driver says people still pass while red lights flashing

All buses in Sooke School District outfitted with stop sign cameras

The cost of potentially counting deer regionwide was among the issues that prompted Capital Regional District committee members to vote against pursuing a greater CRD role in deer management. (Black Press Media file photo)
Expanded deer management a non-starter for Greater Victoria

Capital Regional District committee maintains current level of support

Gem Lake Top, at Big White Ski Resort, seen at Jan. 8. (Big White Ski Resort)
Big White cancels $7.3M in lift tickets, accommodations due to COVID-19 orders

Since November, the ski resort has been forced to make several changes

The Wachiay Friendship Centre hopes to convert its parking lot into a building with living units and a cultural gathering space. Scott Stanfield photo
Friendship Centre proposes affordable housing project on its Courtenay property

The Wachiay Friendship Centre hopes to turn its parking lot at 17th… Continue reading

Campbell River’s new hospital, July 2018
Comox Strathcona board worried over funding more than hospitals

Island Health points to seniors care to reduce demand at acute care sites

Most Read