If you already have an incorporated business or you’re about to start one, you can choose how you wish to be compensated – by way of a salary (including bonuses) or through dividends from shares you own in your company. The choice is up to you – but there are a number of factors that you should know about so you can make the most informed choice.

Salary

A salary is a deduction to your company but it will also attract both employer and employee Canada Pension Plan (CPP) premiums and, in some provinces, payroll taxes.

A salary generates Registered Retirement Savings Plan (RRSP) contribution room, CPP benefits and is necessary if you wish to establish an Individual Pension Plan (IPP).

Dividends

Dividends are paid out of after-tax corporate profits. Corporate income in excess of the small business deduction (SBD) limit ($500,000 federally and in most provinces) is subject to higher corporate tax rates. Dividends paid out of dollars above the SBD are eligible for a more advantageous personal tax rate. Dividends paid with dollars taxed at the lower SBD rate are non-eligible, resulting in a lower Dividend Tax Credit for the shareholder and, consequently, attracting more personal tax than an ‘eligible’ dividend.

A mix of salary and dividends

In the past, tax professionals advised business owners to pay themselves at least enough salary to reduce corporate profits below the SBD limit. But corporate taxes have now been lowered to a point where more tax can be deferred by leaving income in the corporation – so it can make sense to retain high tax rate income inside the corporation for investment. To the extent that you require cash on a regular basis, salary is still the preferred compensation choice until corporate income is reduced to the SBD limit.

A pure dividend strategy

Taking compensation solely as dividends means that you will not be able to contribute to investments held in an RRSP, will lose access to CPP disability benefits and may not qualify for group disability plans. This strategy can, however, allow more income to be saved inside the corporation than could otherwise be contributed to investments held within a RRSP or to an IPP and could more than offset the reduction in future CPP retirement benefits – if you use the correct investment strategy.

Other considerations

Creditor protection – many provinces have rules preventing professional corporations from using holding companies or trusts as creditor proofing strategies so it may be prudent to hold a significant portion of retirement assets in registered IPPs or Guaranteed Income Funds (GIFs).

Addressing compensation issues now will improve your ongoing financial stability and retirement nest egg. Your professional advisor can help make the best choices for you.

This column, written and published by Investors Group Financial Services Inc. (in Québec – a Financial Services Firm), and Investors Group Securities Inc. (in Québec, a firm in Financial Planning) presents general information only and is not a solicitation to buy or sell any investments. Contact your own advisor for specific advice about your circumstances. For more information on this topic please contact your Investors Group Consultant.

Contact David Brown at 250-315-0241 or at [email protected] to book your appointment.