The ongoing discussion of Salary versus Dividends has got to be one of the oldest debates since the dawn of complex taxation. Over the years, I’ve heard many people (accountants included) preach that dividends are the way to go. I cringe at these “one size fits all” solutions.
Salary versus Dividends – how to choose
The increasing Canada Pension Plan (CPP) rates make a dividend only compensation strategy tempting, but consider this:
- Childcare costs can only be deducted against employment (or self-employment) income. If you have dividend-only income, those daycare receipts could be worthless at personal tax time.
- Did you move during the year? Moving expenses can only be deducted against employment income.
- Do you have a health spending account in your corporation? This is only deductible in your corporation if you are an employee of your corporation. You are not an employee if you are only paid a dividend.
- Dividends are grossed up on your personal taxes. This means that your taxable income is essentially inflated for calculating credits and programs that are income-dependent. Dividends will mean reduced Child Tax Benefits or GST credits. For older entrepreneurs, it can mean clawed back Old Age Security benefits.
Perhaps dividends are the most cost-effective method of compensation for you. Consider taking a tiny wage from your corporation so that you are technically an employee and can access benefits and tax credits aimed at people who report T4 income.
Be aware of the consequences of dividend-only compensation.
- No (or reduced) CPP benefits. Think retirement plan and disability payments. Consider taking those employer and employee CPP savings and locking them into a long-term investment plan to save for the lost future benefits.
- No accumulation of RRSP contribution room.
The answer isn’t simple and each individual situation needs to be evaluated separately. Depending on the various taxation policies at provincial and federal levels of government, the ideal compensation strategy can flip flop annually. Make sure your accountant is aware of any changes in your household and personal plans.
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Angela Richardson is a Chartered Professional Accountant (CPA, CGA) with more than 17 years experience working in public practice with small to medium sized businesses. While financial statements and tax returns are part of the occupation, consulting and assisting clients to achieve their entrepreneurial dreams is her true passion.