Most commonly, extra income in the corporation can be sent to shareholders through a salary/bonus or a dividend. This income is then taxed at the individual’s personal tax rate. With the principle of ‘integration’ that is applied in Canada, the taxpayer should be indifferent about earning income through a corporation or personally because they would pay the same amount of tax. In 2014, CRA made changes to equalize tax, meaning it was irrelevant whether the income came from salary or dividends. This integration means that the aim is to have the business owner pay the same amount of tax if you receive a salary from your company or if your company pays tax on the income and you receive a dividend.
Dividends are a distribution of profits of the corporation to the shareholders. When a corporation pays out a dividend from after tax profits, it is not an expense to the corporation so it doesn’t qualify as a deduction for tax purposes. The corporation pays corporate tax on the corporate profits and the shareholder pays tax when the profits are paid to them as dividends. CRA balances this out by taxing dividends at a lower rate. This income will be taxed to the recipient often at a much lower rate than a salary.
The drawback is that this income does not count towards the Canada Pension Plan, nor does it count towards increasing your RSP available room.
Taking a salary, on the other hand, means the corporation will be able to deduct it from its income.
Salary is paid out of pre-tax profit and it counts as employment income to the shareholder, increasing your RSP contribution room and allowing for advanced strategies like IPPs and RCAs. Things to consider:
- You can pay into the Canada Pension Plan and collect benefits later on.
- You can take advantage of personal tax credits such as medical, child care and donations.
- In some provinces, including Ontario, you have to take additional payroll taxes off salaries.
Tip: One common strategy is to take a salary to maximize CPP contributions and RSP space, and then take the rest in dividends. Another is to take enough salary to bring the professional corporation below the small business deduction threshold, and then take the rest as dividends.
Have you reconsidered the most effective mix of salary and dividends lately? Which rate is higher for your personal or corporate tax rate? It may be more favourable to have your income taxed in the corporation as small business income, versus what is being earned by you individually. Every situation is different and for some it may be best to take a blend of income and salary.
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