For an incorporated business owner, whether to be paid in salary versus dividends is always a top question – and one that interestingly always seems to draw a strong, definitive answer. Not surprisingly, a strong, definitive answer is exactly the opposite of what should be the case in these instances.
Social Safety Net
Many will tell you, accountants and non-accountants alike, that dividends are the only way to go. Take dividends; pay less tax! It’s the only way to do it! Sure – that’s generally true. While conceptually you would pay even amounts of tax between being paid salary or dividends thanks to the concept of “integration”, or evening out corporate versus personal income tax, dividends don’t draw CPP. As a result, you’ll save several thousand a year by not paying into CPP.
It’s important to note, however, that CPP is not a true tax expense. It’s really more of an investment in a government pension plan. The question as a business owner then, is, do you want to have access to a social safety net in the form of CPP. If the answer is yes then you should be taking at least some salary in order to contribute CPP. If you don’t, you’re not going to get CPP when you retire.
The Concept of Earned Income
Earned income means income generated from effort – or employment, for instance. Dividends are not earned income – they’re investment income. So even though you’re working your tail off in your business, if you are paid in dividends you don’t have any earned income for tax purposes. This comes into play in one major way – RRSPs.
RRSP contribution limits are based on earned income. So if you only ever take dividends, you’re not generating any RRSP contribution room. If using that is of importance to you, again, you need to be taking a salary.
What’s the “Right” Mix?
Ultimately that is up to you – we have clients all over the spectrum on dividends versus salary based on their specific situation. Your accountant should discuss these factors (and more) with you and help you arrive at a mix of dividends versus salary that you’re comfortable with.
Remember – there is no hard and fast truth here. Every individual is unique and needs their own custom answer to this common problem.