How to Pay Yourself From Your Corporation While Remaining Tax Compliant
So, you’ve built up your business, and now it’s finally time. It’s time to cash in your hard-earned dollars and pay yourself from your corporation – but how? Should you go with the traditional salary route or pay yourself dividends?
Each method has its advantages and disadvantages but will likely yield almost comparable tax savings results (by design). The decision depends on your company's situation and your life specifically. To help with your decision, we'll go over the advantages and disadvantages of each method as well as some things to keep in mind when you've finally decided which route you're going to take. Let's dive in!
Should I Pay Myself a Salary or Dividends?
To first decide whether you should pay yourself a salary (meaning wages) or dividends, it's important to understand the difference between the two and their advantages and disadvantages. We'll look at both types and why you may consider opting for one way over the other or even choosing a combination of both methods.
Paying Yourself a Salary (Wages)
A salary is a method that most individuals are familiar with as this is the form of remuneration that's most often used when being paid by an employer.
This method involves paying yourself a wage consistently for your services and contribution to the corporation. Wages paid to yourself (or employees) would be reported on a T4 and taxed on your personal income tax. Wages/salary are also seen as an expense for your corporation, thereby minimizing your corporation’s tax bill.
Advantages of Paying Yourself a Salary
Deciding which method is suitable for you depends on various factors that are unique to your business’ circumstances. There are numerous advantages of paying yourself a salary over dividends, and those include the following:
Managing Tax Bills
When paying yourself a wage, income tax is withheld and paid directly to the Receiver General. When choosing this method, you will avoid having a surprise tax bill at the end of the year, as taxes have already been remitted.
Creates RRSP Contribution Room
RRSP contribution room relates directly to the income earned as wages in a tax year. If you're not paying yourself wages (and are paying yourself in dividends instead), you will miss out on this investment vehicle.
Allows for CPP Contributions
Wages also allow you to contribute to CPP, whereas dividends do not. This means that when you’re older, you will have contributed to CPP and, therefore, will be able to take advantage of this. CPP contributions are a cost for you and your corporation; therefore, this advantage must be fully considered.
Advantages when Qualifying for Financial Products
Having a reliable wage/salary allows you to qualify more easily for financial products from banks and other institutions as it shows a steady state of income as opposed to dividends which can be paid out sporadically and in varying amounts.
If you plan to apply for a mortgage or a loan on behalf of your corporation in the near future, this advantage is worth considering at least for the two years preceding the time of your application.
Eligibility for Government Programs and Tax Credits
Earning a regular wage allows you to qualify for various government tax programs and credits, similar to COVID-19 benefits, and credits, such as the Canada Workers Benefit for lower-income families.
If being paid a wage/salary sounds like the best route for you, you will need to set up a payroll program account with the CRA, as the necessary deductions will need to be sent to the CRA regularly. CRA sets out how to create a payroll program account here, but you may want to consult a professional to ensure the process is set up correctly.
Paying Yourself Dividends
Dividends are defined as a "distribution of a company's earnings to its shareholders and is determined by the company's board of directors. Dividends are often distributed quarterly and may be paid out as cash or reinvestment in additional stock".
Dividends are not considered a corporate expense and therefore do not reduce corporate taxes the same way wages and salaries do. Dividends are declared on a T5 for each shareholder who received dividends in the subject tax year. The dividend amount paid is directly related to the shareholder's ownership percentage in the corporation.
Advantages of Paying Yourself Dividends
The advantages of paying yourself in dividends can vary depending on your circumstances. The advantages include the following:
Dividends are Simple
Compared to paying out wages, dividends can be simple in terms of how they're paid. If you're the sole shareholder of your corporation, you can declare the dividend and transfer the funds to your personal bank account. Most commonly, dividends are declared once per year. Unlike wages, there's no need to sign up for payroll or send deductions to the Receiver General.
Late Filing Penalties Don’t Occur with Dividends
Unlike paying wages, you won’t be subject to financial penalties when paying yourself if you don’t make the proper deductions within the requisite timeframe. If making deadlines can be challenging for you, dividends might be a good option. However, you must consider your individual circumstances and speak to a professional before coming up with a plan.
It's possible that one method over another may yield a smaller tax bill; however, both approaches are set up so that they generally carry the same tax bill as you’ll either get taxed on the personal side or on the corporate side (depending on the method chosen).
How to Pay Yourself and Stay in Compliance with Rules
When it comes to corporate rules, there's a lot to learn. Working with a qualified professional is a good way to ensure you comply with all the rules. Keeping good records is the first step to ensuring you’re ready should a tax audit occur in the future.
There are various complicated rules that apply to corporations when it comes to paying out dividends; therefore, it's imperative that you understand your obligations with respect to same. One of our previous blog posts touched briefly on the newly implemented tax on split income (TOSI) benefit, which applies when paying out dividends. For more information, you can read the blog post here.
Here’s Where it Gets Complicated
Although it may seem that paying out dividends is a relatively straightforward process, it's possible that you may think you're in compliance with the rules, but the CRA may declare that you’re not.
In a recent Tax Court case covered by the Financial Post, a taxpayer (who was also a chartered professional accountant and licensed insolvency trustee) was reassessed in 2017 under s. 160 of the Income Tax Act for transferring property to him (over $140,500) in the form of dividends at a time when he had a large tax bill owing ($110,000). The issue at hand was whether the taxpayer (who was also the corporation's sole shareholder) should be held jointly and severally liable for the tax owing, plus interest.
The taxpayer’s position was that he paid himself the dividends as services rendered to the corporation, which constituted consideration. The Court evaluated the facts based on the four-part test of the applicable section and referenced a previous 1998 Supreme Court decision which held that “a dividend is a payment which is related by way of entitlement to one’s capital or share interest in the corporation and not to any other consideration and thus the quantum of one’s contribution to a company and any dividends received from that corporation, are mutually independent of one another” And also that “a dividend is a return on capital which attaches to a share, and is in no way dependent on the conduct of a particular shareholder”.
The Supreme Court went on to state that “to relate dividend receipts to the amount of effort expended by the recipient on behalf of the payor corporation is to misconstrue the nature of a dividend”. The taxpayer argued that he paid personal tax on the amount; however,
the Court concluded “a dividend is related to shareholding and not to any other consideration the shareholder might have provided” and found the taxpayer jointly and severally liable for the tax owing under s. 160 of the Income Tax Act.
Avoid Tax Complications, Get Help From a Professional
It’s clear that although you may think you have it all figured out with respect to how you’re going to pay yourself, it could still be improper.
The taxpayer mentioned previously was a chartered professional accountant himself, and he believed that he complied with dividend rules. This is why it’s crucial to keep good business records so that you have the necessary paperwork to fall back on should you be questioned regarding your form of remuneration. In the case of the taxpayer above, should he of potentially settled his tax bill before paying himself dividends? Perhaps. Would that have avoided the re-assessment? Maybe.
Contact a professional to review your remuneration plan if you're unsure about the proper procedures to follow. It's important to remember that at the end of the day, you are responsible for your own tax return.
Having said that, if you’d like to be 100% sure, why not utilize CRA’s Liaison Officer Service? You can speak to a liaison via videoconference, where they can provide a generalized webinar, or they also offer personalized visits. They provide general information regarding tax procedures and more specific information regarding common, occurring tax errors and how to avoid them.
At the End of The Day, Act in Good Faith
Perhaps now you're more confused than ever; however, this is not a one-size fits all approach. The type of remuneration that is best for you will depend on your business circumstances and your life.
The critical thing to remember is that if you choose to take a particular route, you're not stuck with that route forever. Perhaps you want to focus on making RRSP contributions and need a regular income stream; therefore, a steady and predictable salary is more realistic for you.
Perhaps you can afford to grow your business by keeping money within it and paying yourself only sporadically, so maybe a reasonable dividend or an occasional bonus is the way to go.
No matter what you choose, keeping accurate records of your business income and expenses is crucial to avoiding a tax problem. What's even more critical is asking for assistance with this part of your business.
You might be very confident in your choices, but at the end of the day, it may not turn out the way you planned. Just know that if you act in good faith and keep accurate records, you'll get through any hurdle thrown at you.
Contact us today to set up your remuneration plan so that you can set yourself up for success and take advantage of your hard-earned dollars!