DIVIDENDS vs. SALARY for Small Business Owners in CANADA
One of the common dilemmas the small business owner is facing when the tax season approaches, is whether to get paid
by dividends, or by payroll, putting on the scale total money outcome for both the individual, and the corporation.
Many of us have heard or read that first 40k of dividends are essentially tax-free for an individual. Being such an
attractive perspective, most of us can just wonder, how did he or she not come across that valuable information earlier,
and why the accountant has not told anything?
A little bit of theory should be reviewed first, in order to do that, let us use Ontario tax rates in our examples, for the
specific tax year, and assume that the owner and the corporation are both located in same province. Please also refer to
the notices at the end with respect to information used in this article.
Salary/wages are an expense for your corporation, and are income to you as an individual. With small business corporation
rate approximately equal to 15%, assuming it is located in Ontario, the company will save about 6.27k ([40,000+1,807 CPP company part]*15%)
in income taxes after paying a 40k salary, assuming it has a net income for that year.
An individual, who is Ontario resident, receiving 40k income, will
pay on average 7.4k in CPP and Tax.
The company will pay it's part of CPP of 1,807 dollars on top. Adding 7.4k with 1.8k we
have an approximate 9.2k tax cost for the company and employee together.
Dividends have to be paid out of company income, for that enough net income needs to be declared
before the dividends can be paid. The company will then have to pay 6k of income tax on 40k net income, and the recipient will be issued
a T5 slip that contains following numbers:
BOX 10 Actual amount of dividends 40,000
BOX 11 Taxable amount of dividends 47,200 ( 40,000*1.18)
BOX 12 Dividend tax credit 5,200 ([47,200-40,000]*13/18)
Taxable amount of dividends of 47,200 is also called a grossed up amount of dividends as 40,000 is multiplied by the
factor of 1.18 in order to arrive at the amount that will be included as your income on line 150 of your personal tax
return.
Dividend tax credit is calculated as 13/18 of gross-up amount, and in our case is equal 5,200. Due
to this credit, along with the personal basic tax amount, the tax that you pay on the first 40k of dividends is 887
dollars.
Thus, in total we get around 6.9k in total tax cost for owner and the company.
The matter gets more complex if one has a combination of several types of income. The most common scenario is a mix of salary and dividend income.
Let us review an example where there is already some salary, and now we need to make a choice between paying salary/bonus,
or the dividends.
Suppose the taxpayer is single, living in Ontario and already has 31,500 salary during the year, to which the following
taxes apply:
Tax: 3,900
CPP: 1,386
CPP on self-employment/company part: 1,386
EI: 0 (Exempt if owner and director)
Total: 6,672
- for Dividends of 25,000 on top of that income, the extra tax is calculated from the following T5 data:
BOX 10: actual amount paid: 25,000
BOX 11: taxable amount of dividends: 29,500
BOX 12: dividend tax credit: 3,250
Then line 150, the total income will be calculated as combination of salary of 31,500 and taxable dividends of 29,500,
and be equal to 61,000 Balance of extra tax on the personal tax return in this case is 3,533 in addition to originally owed amounts.
Additional income tax for corporation in order to show extra income from which it pays 25,000 dividend will be approximately 3,875, making the total
extra tax equal to 7,408
OR
- if additional salary or a bonus of 25,000 is paid:
Then line 150 total income will amount to: 56,500 Balance of extra individual tax and CPP owing is 7,216
Additional tax for corporation is the employer portion of CPP Contribution or CPP on self-employment earnings amounting to 1,040
That makes the total extra tax cost of 8,255.
Comparing the two cases, tax advantage from receiving dividends as opposed to extra salary is about 847 dollars, which is less than if all income
came in form of the dividends.
The 3,875 corporation income tax cost must not necessarily be incurred in the same year, as the corporation might have earned income
in the past not yet distributed it to the shareholders. If the corporation declares net income in the current year, it pays approximately
15.5% of taxable income.
Retirement planning
One must be careful to plan financial affairs noting that although dividend strategy appears to help saving money, it may adversely affect the
pension as no CPP is deducted from the dividends. The pension calculation system should be reviewed so that the future benefits are not affected.
Dividend Sprinkling
There are certain advantages in income splitting strategies using dividends. Under specific conditions, the
attribution rules will not apply directly as they do in case of salaries paid to family members. One of such strategies
is "dividend sprinkling", where family members are issued different classes of voting and non-voting shares, and each class
is assigned dividends according to the shareholder's tax bracket.
Eligible Dividends
We should note, that the Income Tax Act differentiates between eligible and other than eligible dividends. Eligible
dividends are the dividends paid from the income that was taxed at the large corporation tax rate, so there was no federal
and provincial small business deduction. For corporation operating in Ontario this would mean additional 17.5% of tax,
bringing the average rate from 15.5% to approximately 33.5%. The recipient of eligible dividends will pay less personal tax
on them. For the small business corporation, however paying eligible dividends is not practical, and therefore other than
eligible dividends are usually paid. These are referred simply as dividends in this article.
Personal Services Business
Another important matter to be considered by the IT Consultants and other Independent Contractors is possible reassessment of the corporation
as Personal Services Business by the CRA.
Corporate Tax rate in that case rises from 15,5% to about 38%, and the dividend strategy will be at a great disadvantage
as it requires the corporation to report profit before dividends are paid. Refer to "Personal Services Business - a concern for IT Professionals?"
for more details.
The table and chart below show the tax values for Salary and Dividend Income for the range between 20k and 200k a year, assuming Ontario
provincial tax.
Salary / Gross Pay............................................................Tax and CPP, including Company Part
...........20,000.........................................................................................................................3,150
...........30,000.........................................................................................................................6,253
...........40,000.........................................................................................................................9,182
...........50,000.......................................................................................................................12,569
...........60,000.......................................................................................................................16,018
...........70,000.......................................................................................................................19,133
...........80,000.......................................................................................................................22,501
...........90,000.......................................................................................................................26,106
.........100,000.......................................................................................................................30,433
.........150,000.......................................................................................................................52,477
.........200,000.......................................................................................................................76,424
Dividends Paid........Dividend Personal Tax......Corporation Income Tax.................Total Tax Cost
...........20,000..........................216..........................................3,100......................................3,316
...........30,000..........................300..........................................4,650......................................4,950
...........40,000..........................887..........................................6,200......................................7,087
...........50,000.......................2,943..........................................7,750....................................10,693
...........60,000.......................4,790..........................................9,300....................................14,090
...........70,000.......................7,058........................................10,850....................................17,908
...........80,000.....................10,111........................................12,400....................................22,511
...........90,000.....................13,403........................................13,950....................................27,353
.........100,000.....................16,694........................................15,500....................................32,194
.........150,000.....................34,793........................................23,250....................................58,043
.........200,000.....................54,340........................................31,000....................................85,340
Please use the above numbers as reference only, as every taxpayer's situation is unique and
offers various opportunities for tax savings and right tax strategy. Contact us
for no obligation evaluation and free of charge initial consultation.
Important notice(1): The information above may reflect a
subjective interpretation by the author(s), who, by no means may accept
any responsibility or
liability whatsoever for the results of proper or improper use of the
above information, whole or in part, it as well is explicitly stated
that
whatever information provided by authors, may not suit specific purpose
of specific reader, and it alone may not be relied upon to produce
decision.
In each individual case professional advice must be obtained.
Important notice(2): This text is subject to copyright (c)
legislation and may not be reproduced, whole or in part without
author(s) written permission.
