Which option has lower taxes?
For owners of small business corporations making less than $500,000 in Canada, here are some general concepts:
- When the corporation earns profits, the cash belongs to the corporation, not the owners. They cannot use those profits for personal spending without first declaring the payment as income.
- The corporation cannot lend money to the owners without tax consequences. If the owners have drawn cash, borrowed money, or used the corporate bank account for personal expenses during the year, that money needs to be repaid, or taken as a wage or dividend prior to year-end.
- Every business owner needs to be familiar with the rules around personal expenses and business expenses. If the business pays for a personal expense of an owner, it's really like the business paying the owner cash, and then the owner paying for that expense. The payment should be included in the taxable income of the owner.
Paying yourself in dividends
When you pay yourself in dividends, you get paid as a shareholder (or an owner) of the corporation. The corporation issues T5 slips to the owners showing the amount of dividends paid. The figures from the T5 are then used to calculate tax owing on your personal tax return.
- Dividends are not a tax deduction. They are a distribution of profits (usually), which means the corporation likely has taxable income.
- The corporation will pay some of the tax, and the owners will personally pay some of the tax. Owners should expect to owe tax personally.
- Dividends are taxed lower than wages at the personal level to reflect that the corporation has already paid a portion of the taxes. When comparing taxes owing between wages and dividends, be sure to include the corporate tax as well.
- No Canada Pension Plan (CPP) or Employment Insurance (EI) is payable on dividends.
- Dividends do not create RRSP contribution room. Only earned income creates RRSP contribution room.
For simple reporting, add up all the draws during the year and file a T5 slip by February 28.
- Personal taxes on dividends are due to be paid by April 30.
- If your only income at the personal level is dividends, you declare about $20k without paying any tax.
Paying yourself in wages
When you pay yourself in wages, you get paid as an employee of your own business by being put on payroll, or declaring a one-off bonus. The corporation issues a T4 slip showing the amount of wages. These must be filed by February 28.
- Wages are a tax deduction to the business, meaning the business will not be taxed on the amount of the wage.
- Wages are taxed personally at the applicable personal tax brackets. Learn about combined federal and Alberta tax brackets.
- For CPP, 11.9% must be paid on wages between $3,500 and $66,600. Half is paid by the employee and half is paid by the employer. Wages over $66,600 per year are exempt from CPP, so the maximum owing in a year is $7,509, or $3,755 each for the employee and employer.
- Owners are exempt from paying EI premiums.
- Wages are “earned income," which increases your RRSP contribution limit. RRSP contributions can be used to reduce your tax.
Get on payroll and have the company pay the income tax and CPP for you. Monthly payroll remittances are due 15 days after the month when the owner got paid.
Which option has lower taxes?
Generally, total taxes on wages are lower than dividends, but wages tend to be more expensive because of the CPP.
To recap, dividends seem easier, but you still need to save a percentage of each dividend draw for your personal taxes and make corporate and personal income tax instalments. You may end up paying more tax than salary, and you must be more active in your retirement planning.
When you pay yourself a salary, you invest for retirement by paying into CPP and contributing to RRSPs. You are eligible for CPP, Canada Workers Benefit and COVID-19 relief. You also get your business to pay your taxes, so you owe nothing or get a refund come tax time.