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How to Pay Yourself from a Corporation: Salary vs Dividends in Alberta
Note: This article is for informational purposes only and does not constitute legal or financial advice. Laws and regulations can change. For financial or tax advice, consult an accountant or tax advisor.
One of the benefits of incorporating a business is that it provides you with additional options to pay yourself as the owner. Incorporated businesses can pay their owners by way of a salary, through dividends, or using a combination of both.
Deciding how to pay yourself when you own a corporation in Alberta can be a complex task. The choices you make could significantly impact your corporation’s tax situation and your personal financial planning.
We’re diving into the primary ways you can pay yourself—salary vs dividends—under Alberta and federal laws. We’ll explore the pros and cons of each method to help you make an informed decision.
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Salary vs. Dividends: The Core Differences
When you pay yourself a salary, it becomes a deductible expense for your corporation. This lowers your corporation’s taxable income. Dividends, on the other hand, are paid out of after-tax profits and are not deductible expenses.
CPP and EI Contributions
Choosing to pay a salary means you’ll incur additional costs, such as employer contributions to the Canada Pension Plan (CPP) and Employment Insurance (EI) if applicable. While there is certainly a benefit to be had by paying into CPP and EI, some people would rather use this money to invest it on their own, without being subject to government withdrawal restrictions or risking these government services from being depleted before you can take advantage of them.
CPP and EI are not required to be paid if you pay yourself dividends. Just make sure that you have your own plan for retirement and potential loss of employment.
A salary can offer advantages in personal financial planning. Not only does it force you to save for retirement by paying into CPP, it also provides Registered Retirement Savings Plan (RRSP) contribution room which is not the case with dividends.
Paying a salary can also help you to qualify for financing, including mortgages and loans. Some, but not all, banks will take dividends into consideration when evaluating your credit. For this reason, it’s important to check with your lender if you are planning to obtain future financing to make sure that your total income (dividends and salary) will be taken into account.
Administrative Burden and Complexity
Paying salaries requires that the corporation set up a payroll account with CRA. It also requires regular reporting and remittances. This can be a pain for busy business owners. There are accountants and other service providers who can assist you with this, but it will come with a cost.
Dividends require less administrative work and are less complex. They don’t require a T4, payroll calculations, and regular payroll remittances, making them easier to manage than a salary.
By paying dividends instead of salary, you may also be able to delay the payment of tax, as dividends can be declared at the end of the corporation’s fiscal year.
Forced Savings with Salaries
By law, the corporation has to withhold income tax and CPP contributions from your salary. Unlike dividends, this leaves no room for deferring these payments to the following tax year.
The immediate effect is twofold.
First, it ensures that the corporation sets aside enough funds to cover not just your salary but also your personal tax obligations. These withheld amounts are then remitted to the government, essentially pre-paying your personal tax liabilities.
Second, a steady salary instills financial discipline in your personal spending, allowing for a more predictable and stress-free budgeting process.
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Common Pitfalls to Avoid
Payments to Family Members
Be cautious when paying salaries or dividends to family members, as these need to be reasonable for the work performed. Otherwise, you risk additional tax and potential penalties from CRA.
When paying dividends to multiple shareholders, make sure that your corporate share structure allows for the payments you are making. This often requires including a broad and flexible share structure in the Articles of Incorporation, and ensuring that different shareholders (especially if they are related) hold a different class of shares. Unfortunately, creating a flexible share structure is not something that is done by most online incorporation service providers. This means that expense changes may be required at a later date to provide for dividend flexibility.
Saving for Tax
If you are paying significant dividends, make sure to set money aside to cover the tax obligation when it comes time to pay. It’s fairly common for business owners to set money aside to cover the tax if it’s not taken directly off of their cheque. This can lead to late payment penalties and interest from CRA as well as debt problems.
Maintaining accurate records is crucial. If you are paying salaries, this means properly documenting your payroll obligations and remittances. If you are paying dividends, this means ensuring that the dividends are properly documented by way of a director resolution recorded in the corporate minute book.
Balancing Act: Salary vs Dividends
Many business owners find that a balanced approach works best. You can pay yourself a reasonable salary to qualify for financing and deductions, and take additional profits as dividends. This strategy can also help you avoid issues with Tax on Split Income (TOSI) rules that may apply to dividends paid to family members.
If you’re wondering which approach, salary vs dividends, will result in the least tax, then you’ve come to the wrong place. Determining what will work best for you requires an analysis of your specific business, the ownership structure, and the tax situation of each individual owner. Unfortunately, it’s not something that can be determined by reading a blog post.
For personalized advice tailored to your specific needs, we strongly recommend consulting with a qualified accountant or tax advisor.
Whether to pay yourself a salary, dividends, or a combination of both involves multiple factors, each with its own set of benefits and drawbacks. Careful planning and consultation with financial experts can help you make the best decision for both you and your Alberta corporation. To ensure that you retain the flexibility to issue dividends to different shareholders, it is important that you incorporate your business with a professional who understands these issues. That’s where we can help.
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