Dividends vs. Salary: 5 Tips to Help You Choose How to Get Paid From Your Corporation

It’s not always easy to come up with a topic to write every week. Recently, someone suggested to me that I should write about how to teach finance to kids these days.

I dragged on to write about this for weeks.

Quite frankly, I couldn’t wrap my head around it.

My kids are close to 3 and 1.5 years old now. My younger one doesn’t walk yet.

Although buying a house for each of them makes complete sense to me, how can I ensure that they don’t become one of those spoiled kids in their twenties that takes everything for granted?

I can’t.

Recently, a guy in the audience asked Philip McKernan, a famous life coach who presented at both the Rock Star Member Event in October and the Archangel Summit in Toronto in September, for parenting advice.

His response? Philip believes that we, as parents, will just have to accept that no matter how hard we try, we will always screw them up! And there’s nothing we can do about it. 🙂

I am going to go with my gut feeling.

I bought my young kids a piggy bank. My husband loves to leave his change from his pocket every day. My daughter is now responsible to pick them up and deposit them into the “bank”.

When she asks me to buy her stuff, I remind her to check whether her piggy bank has enough money to buy it. 🙂

She doesn’t really understand much of the money concept yet, but I figure that it is never too early to start conversations.

And of course, I also take her to our rental properties once in a while, showing her what mommy and daddy are doing.

Demonstrate by example ~ that’s always my parenting philosophy.

Now on to this week’s topic – dividends vs salary

When you own your business or properties inside a corporation, there’s always a tax impact when you take the money out from the corporation.

There are two common ways to do so – one is by way of salary and the other is dividend.

What’s the difference between the two of them?

1. Salary is a deductible expense and a dividend is notLet’s use an example to illustrate. Say a corporation makes $400,000 before paying a salary. Now they have to decide whether they should pay the salary or dividend.Say the corporation pays $100,000 to the shareholder as a salary, the corporation is taxed on $300,000 at 15%. The individual who receives the salary will then pay tax on the $100,000.

   Now, if the corporation decides to pay the dividend instead, the corporation would first get taxed for $400,000 at 15%. The individual then receives the $100,000 as dividend.

2. There’s an additional cost involved, such as CPP & EI when you pay a salaryWhen the corporation pays a salary, it is also required to withhold taxes, employee’s portion of Canada Pension Plan and Employment Insurance and remit them to the government.When you are getting paid for $100,000 salary, you always know that your net amount is never $100,000.As an employee, you are responsible to make contribution to CPP & EI. You are of course also responsible to pay personal income tax on the $100,000 you earn.CPP is maxed out at $2,544.30. EI is capped at $836.19.

   The employer, in this case, the corporation, is also required to make the same amount of contribution of CPP and 1.4 times of EI.

   If you own the corporation, more often than not, we advise the clients to opt out from paying EI. The theory behind it is that you cannot.

   In another words, the corporation is incurring an additional deductible expense of $2,544.30 if it chooses to pay you a salary instead of dividend.

   If you combine the employee portion and employer portion of CPP, the total cost is more than $5K that you would not otherwise need to pay if the corporation chooses to issue a dividend.

3. Salary can give the taxpayer RRSP contribution room, qualify for financing & enable you to deduct childcare expenseAlthough the costs seem to be higher with salary, there’re some other benefits from paying a salary.RRSP contribution limit is calculated as a percentage based on earned income. Salary is one of them but dividend isn’t. If you want to save money in your RRSP account, paying yourself via dividend won’t work.

   Banks look at employment income more favorably when you apply for a mortgage. Paying yourself a salary can allow you to qualify for more mortgages and hence enable you to purchase more properties.For the parents out there with young kids, you may incur childcare expenses, of which a portion of it is deductible against your income. It is only deductible against the lower income spouse’s earned income.

   Dividend income is not part of the definition of earned income but salary is. In another word, if you make $100,000 dividend income, you’re the lower income spouse and you also incur $8,000 of childcare expenses, you will NOT be able to deduct the $8,000 expense in your personal tax return.

4. You are entitled to an additional employment amount (as a personal tax credit) if you are paid a salaryWhen you earn a salary, you get another $1,146 employment amount as non-refundable personal tax credit. Self-employed individual are not eligible to claim this amount unfortunately.Calculated on the base personal tax rate, this is equivalent to $1,146 x 15% = $172 non-refundable tax credit.

   Of course, this isn’t available when you earn a dividend income.

5. Salary has to be reasonable when the employee is relatedWhen you pay a lower income spouse or adult children a salary, it has to be a reasonable amount.The family members must work for the company and the amount must be comparable to market.But when you declare a dividend, you can choose the amount you pay them.See my earlier blog post about splitting income with lower income spouse.

Okay, it is not a simple answer, is it?

Speak to a professional accountant that knows your personal situation before making a decision. Don’t forget to consider the five points illustrated above.

Until next time, happy Canadian Real Estate Investing.

Cherry Chan, CPA, CA

Your Real Estate Accountant