As a business owner, you can pay yourself from your corporation through salary, dividends, or a mix of the two. There is no single right answer. The best mix depends on your situation, and each option carries trade-offs worth understanding before you decide. This post walks through the main factors, in plain terms, so you can see what shapes the decision and where it pays to plan ahead.
Personal taxes: a major expense
Once a tax year closes, most of us reflect on what went well and what did not. Taxes are one of the largest expenses a taxpayer carries, and the amount we contribute each year is felt by everyone.
How you, the shareholder-manager, influence your tax bill
The close of the tax year marks a milestone: the end of the compliance side of tax, which is mostly filing the return and either paying what is owed or receiving a refund. Compliance works on a year that is already closed. You can optimize a closed year, but not nearly as much as you can influence the year you are currently in and the years ahead. That influencing is called planning, and it is where most tax optimization happens. To understand both sides of tax, visit our Tax page.
For a business owner, some of the major levers of tax planning are the salary-and-dividend mix, retained-earnings strategy, and the timing of asset purchases. For an owner whose income comes mainly from the corporation, the salary-and-dividend mix is the one felt most closely, because it is a major driver of personal tax.
You set up the corporation to defer tax, but you need money to live on: the trade-offs begin
The corporation was set up to defer tax, but you cannot take money out of it the way you take money out of a bank account. Most money you take out of the corporation is taxed in your hands. This is one of the biggest trade-offs that comes with incorporating.
For living and personal expenses, you can usually draw a salary, dividends, or a combination of the two, in whatever mix produces the most efficient tax result. The mix is a genuine choice. There is no universally right or wrong answer, but every version of the choice carries its own trade-offs. A few of those are explained below.
Factors that influence the salary-versus-dividend trade-off
Before we begin, note that this discussion is simplified for general educational purposes. The subject is technical, and you may want the help of a CPA tax advisor to understand how it applies to your own situation.
With that said, here are a few of the factors that shape the trade-off:
- We should consider the combined personal and corporate federal, provincial, and territorial tax rate against the personal combined federal, provincial, and territorial dividend tax credit. In most cases, when your combined dividend tax credit is greater, taking money from the corporation through a dividend is appropriate. In most cases, salary is more appropriate when the reverse is true.
- Where the use of your personal tax credits and deductions calls for a payout through salary, that can override the rate considerations above. The combinations are too numerous to cover in an educational piece.
- In Alberta, there is no payroll tax. In British Columbia, Ontario, Manitoba, Newfoundland and Labrador, Quebec, Nunavut, and the Northwest Territories, once a corporation’s total payroll exceeds a set threshold, the province or territory charges a percentage of total payroll as a tax. In these jurisdictions, where adding the owner’s salary to total payroll tips it over the threshold, the owner may consider taking a dividend instead.
- Keep in mind that salary is a deduction, so it reduces your corporate profit and can even create a loss. This is where long-term, CFO-level thinking matters: how does a salary fit into the tax-efficient picture over time?
- Salary also has costs:
- Payroll administration, CRA payroll remittances, and the preparation and filing of T4s all carry an administrative cost.
- If you control more than 40% of the voting shares of the corporation, your employment is generally excluded from Employment Insurance, so EI premiums do not apply to your salary. Below that threshold, a salary is generally insurable and EI usually applies, though insurability ultimately depends on the facts.
- Canada Pension Plan (CPP) is different: a salary generally requires mandatory CPP contributions, while dividends do not attract CPP at all. That makes CPP a genuine trade-off between salary and dividends, which the next section examines.
With these factors in mind, here are some of the trade-offs involved in the salary-versus-dividend decision.
Salary-versus-dividend trade-offs
Participation in an RRSP or Registered Pension Plan (RPP)
The RRSP is a feature of the Canadian tax system and a valuable retirement-planning tool that merits its own discussion. Put simply, your RRSP deduction limit is the lesser of a ceiling set each year or 18% of your earned income. Dividend income is not included in earned income, but salary is. An RPP may offer you a larger deduction. Your wish to participate should be balanced against the costs of participating in an RRSP or RPP, but the decision is ultimately yours.
Participation in the Canada Pension Plan (CPP) or Quebec Pension Plan (QPP)
CPP differs from an RRSP in that your CPP retirement income is provided by the Government of Canada and does not depend on the returns your contributions earn. RRSP and RPP income, by contrast, depends on the return your contributions earn. If you want a relatively more secure CPP income stream in retirement, you will need to take a salary from your corporation, with its associated costs and its effect on your income tax.
Childcare expenses
Claiming childcare expenses requires earned income, and one component of earned income is salary. Dividends are not considered earned income under CRA rules. Other rules apply to the childcare-expense deduction, and you may contact a tax advisor for the details. In short, the childcare-expense deduction may require you to take a salary from your corporation.
Cumulative net investment loss (CNIL)
To put it simply, if your investment expenses are greater than your investment income, the CRA records those net losses in an account called the cumulative net investment loss (CNIL). This account comes into play when you want to claim the lifetime capital gains exemption, especially on the sale of your qualified small business corporation shares. A positive CNIL balance reduces the exemption you can claim. Dividends are considered investment income, so paying dividends reduces your CNIL balance and restores your access to the lifetime capital gains exemption. This is one situation in which you may take a dividend, even though it is not the best income-integration strategy.
Your age, preferences, and the stage of your business
If you are approaching retirement, you may want to draw more from your corporation. If you are more risk-averse, you may want to draw cash out and place it in a relatively safer investment. If you want to grow the business, you may want to leave as much money as possible inside the corporation to reinvest. These and similar considerations will influence how much you withdraw and the tax that comes with it
Dividends paid to low-income family members
In limited cases, paying dividends to adult family members who hold shares can reduce the family’s overall tax. This is constrained, though: the Tax on Split Income (TOSI) rules generally apply to dividends paid to family members and tax them at the highest rate, which removes the benefit. The strategy only works where a family member genuinely falls within one of the TOSI exclusions. Because those exclusions are narrow and fact-specific, this is an area to confirm with a tax advisor before acting.
A final word
This has been a brief look at the most significant lever in tax planning: salary versus dividends. The takeaway is that it is a trade-off that deserves serious thought and planning, and the best time to plan is during the year you are in, not when you file your return. The factors here are the most common and widely applicable, but you may have other circumstances that are not covered, and the combinations are too numerous to address fully in one post.
Salary versus dividends is only one of several decisions that shape an owner’s total tax position. The right answer depends on how your corporation earns its income, how much you need personally, and what you are trying to accomplish over the years ahead. As a Calgary CPA practice, we work with owner-managed businesses across Calgary and the surrounding area, and we would be happy to start with a straightforward, no-obligation conversation about your business and your goals.
About the Author
My name is Waheed Khan. I am a seasoned senior financial leader and Controller, and the founder of Radiant Skies Advisory & Accounting, a Calgary CPA practice. Holding an MBA in Finance from McGill University alongside my CPA and CFA credentials, I specialize in helping businesses reduce financial guesswork, optimize cash flow, and regain operational control. My goal is to handle the heavy lifting of compliance and strategy so you can focus on growth.