How To Pay Yourself from Your Business in Canada

If you own an incorporated business in Canada, deciding how to pay yourself is an important decision that impacts your taxes and overall financial plans. The two most common methods of receiving a payout from your small business are through dividends and salary expenses. Paying yourself using the dividend or salary method has specific advantages and disadvantages.

The key considerations when deciding between paying yourself from your small business in Canada are tax efficiency, personal and business financial goals, and retirement plans. This article provides all you need to know about paying yourself from your small business and breaks down the key considerations and differences between salary and dividends.

To choose the right option for your business, you need to understand the key differences between salary and dividends when it comes to paying yourself from your business.

A salary is a regular payment made to you as an employee of your business. It basically means you are put on your business’s payroll, which rolls up under your financial books as a payroll expense. Your salary payments are subject to payroll taxes and deductions, such as CPP (Canada Pension Plan) contributions and income tax.

Dividends are distributions of your company’s after-tax profits to shareholders. If you own a small business corporation, you are a shareholder in the business and can receive dividend payouts. Dividends do not require payroll deductions and are taxed differently than salaries.

Paying yourself a salary involves treating yourself as an employee of your business. This method of paying yourself from your business has its benefits and drawbacks.

Advantages of Salary Payments

• RRSP Contribution Room: Paying yourself a salary enables you to save for retirement in a tax-efficient manner through the RRSP (Registered Retirement Savings Plan). Your salary payment from your business is considered earned income when the Canada Revenue Agency calculates your contribution room. Your RRSP deduction limit is calculated as the lower of 18 percent of your earned income from the previous year and the annual RRSP limit, which was $31,560 for the 2024 tax year.
• CPP Contributions: If you receive salary payments, you are required to make payroll pension deductions, such as the Canada Pension Plan. The CPP provides retirement and disability benefits for when you retire. Having a pension plan also benefits your dependents, such as your spouse, common-law partner, and children.
• Steady Source of Income: Most financial institutions require a steady source of regular income to approve loans such as a mortgage. As a small business owner in Canada, a salary payment can be beneficial when applying for loans or when you need to prove you have a regular source of income.

Disadvantages of Salary Payments

• 1. Higher Personal Tax Rates: The Canada Revenue Agency calculates your personal income taxes using your effective tax rate and your taxable income. Income tax rates in Canada increase as your income tax bracket increases. Your business salary is considered taxable income, which causes your tax rate bracket to increase. As a salary earner from your business, your income tax rate can be higher than the tax rate on dividends.
  2. Payroll Administration: The administrative part of setting up yourself for payroll payments can be complex. To pay yourself a salary from your business, you need to set up payroll, remit taxes to the CRA, and issue T4 slips, which identify all of an employee’s remuneration paid by an employer in a calendar year.

Dividend Payments Explained
The second common method of paying yourself from your business in Canada is by dividends. Dividends work differently from salaries, mainly because they are paid from the after-tax profits of your business. Generally, dividend income in Canada has a lower rate than salaries. Here are the key advantages and disadvantages of receiving compensation from your business through dividends.

Advantages of Dividend Payments

• Tax Efficiency: Paying yourself a dividend from your small business may be more tax efficient due to the dividend tax credit. The Federal dividend tax credit generally results in lower dividend rates than income taxes on salaries.
• Flexibility: As a business owner, you can make the financial decision to pay yourself dividends at any time and in any amount. This flexibility allows you to manage your income more effectively.
• No CPP Contributions: If you need to retain more money in the short term, you can use dividend payouts as they do not require additional cash outflow through CPP contributions as needed in salary payments.

Disadvantages of Dividend Payments

• No RRSP Contribution Room: The income you receive from your business through dividends does not contribute to your RRSP contribution room, thereby limiting your ability to contribute more to your retirement savings.
• Dependent on Profits: Dividends are after-tax profit payments. You can only pay yourself if your small business has sufficient after-tax profits.

Salary vs Dividends Comparison Table

Here’s a side-by-side comparison of salary and dividends to help you make the best decision for your business.

For example, if you earn $100,000 through salary, you may fall into a higher taxable personal income bracket between $57,375 to $114,750, attracting higher tax rates of 20.5%. In contrast, payments earned through dividends may have lower tax implications on your personal income.

CPP and Retirement Planning

The Canada Pension Plan is an important part of retirement planning for Canadians. As a business owner, you need to plan for retirement savings through the CPP or Registered Retirement Savings Plan (RRSP). When you pay yourself a salary, you can contribute to your pension plan through the CPP or using direct RRSP payroll deductions.

An effective retirement plan can provide a reliable source of income when you retire. On the other hand, when you receive a dividend payout from your business, this does not contribute to your Canada Pension Plan, and you will need to find alternative ways to save for retirement.

Scenarios for Choosing Salary or Dividends

When to Choose Salary
As a small business owner with an incorporated business, you may consider paying yourself a salary in specific situations, such as:

• when you need a steady source of income for personal expenses or as a requirement for loan applications.
• when you want to maximize your RRSP contribution room and plan for your retirement through the Canada Pension Plan payroll deductions.
• when you are eligible for EI (Employment Insurance) benefits and can deduct contributions directly from your payroll expenses.

When to Choose Dividends
In contrast, your small business may benefit from a dividend payout. You may consider compensating yourself from your business in Canada if:

• Your business has generated significant after-tax profits after maximizing eligible business expense deductions and other corporate tax benefits.
• You want to take advantage of the dividend tax credit and minimize personal taxes with a lower dividend tax rate.
• Your business goals include expansion in the short term.

Hybrid Approach (Salary + Dividends)

You may decide to use a hybrid approach when receiving payments from your business. A hybrid payment approach combines the benefits of getting paid through a salary and dividends. For instance, you can maximize tax benefits while planning for retirement goals by paying yourself a part salary to build your RRSP contribution room and CPP benefit and part dividends income to take advantage of lower tax rates. A tax consultant can help you analyze the tax implications of a hybrid compensation strategy.

Administrative Requirements

The administrative requirements for businesses differ when paying an employee salary and when paying shareholders dividends.

Salary Setup

To receive salary payments from your business, you need to set yourself up as an employee. This usually means registering for a payroll account with the Canada Revenue Agency. In addition, you need to set up regular payroll deductions for the Canada Pension plan, Employment insurance, income taxes, and other required deductions. When filing income taxes, your business will need to issue a T4 tax slip that shows your remuneration as an employee. Late payroll remittances can result in penalties and interest charges.

Dividend Setup
Receiving dividend payments as a shareholder in your business will require you to document a dividend declaration through a resolution by the board of directors. You will also need to issue a T5 slip, which reports your investment income as a shareholder.

FAQs About Salary vs Dividends

Are Dividends Taxed Differently Than Salary?

Yes, dividends are generally taxed at a lower rate than salaries due to the dividend tax credit. Salaries are taxed using your personal income tax rate, which increases as your income tax bracket increases.

Can I Pay Myself Both Salary and Dividends?

Yes, you can pay yourself a salary and also receive dividends from your business. A mixed compensation approach may be beneficial for tax and retirement planning strategies.

How Do Banks View Dividend Income for Loans?

When reviewing loan applications, banks often prefer applicants to have a steady and regular source of income. Dividends are not a regular source of income, and banks may require additional sources of income to approve a loan application.

Best Practices for Choosing Compensation

Best practices for choosing an effective compensation plan include consulting a tax professional, considering long-term financial planning, and factoring in provincial tax variations.

Consult a Tax Professional

As every business is unique, consulting a tax professional can help you optimize your compensation strategy. A tax professional will analyze your personal and business goals to proffer the best solution to maximize your tax benefits.

Long-Term Financial Planning

Consider your long-term financial goals when choosing to compensate yourself from your business through dividends or salary payments. It is important to balance your personal retirement plans and your business’s corporate needs.

Provincial Variations

Depending on your province, the tax implications of paying yourself a salary or dividend may vary depending on your province. For example, Ontario and Alberta have different provincial tax rates that can affect the overall tax impact of your method of compensation