Which results in the least tax?
Which results in the most cash?
I met with a new client, Mary, to review all the issues and her questions about starting a new business. The question "How should I pay myself?" always comes up in this conversation.
I begin my explanation: "You have only two choices, wages or dividends."
"I just want to do whichever is best," she injects.
My response: "Well, that depends on you, your circumstances and how you define best."
The following are some factors you need to consider before you decide which is best for you!
What are wages and dividends, and how are they taxed?
Wages are paid to employees for work done for corporation.
Dividends, on the other hand, are like a return on investment, paid to shareholders from company profits.
Wages are deducted from corporate income. So there is less corporate profit and less corporate tax.
Dividends are paid from company profits after the company is taxed. Dividends do not reduce profit, so company tax is higher.
Wages are included in your personal income. You pay personal tax on wages.
Dividends are also included in your personal income, but the tax rate is lower because your company already paid some taxes on its profits.
To be fair, the government has created a system so the total taxes paid on funds you receive are close to the same, regardless of whether you receive wages or dividends.
When you receive wages, you pay all the taxes. When you receive dividends, your company pays some of the tax, and you pay the rest.
In Alberta, paying wages creates a tax saving of 3.6% or more, depending on your tax bracket.
If paying the least tax is your primary goal, I vote for wages as the option of choice.
Some people promote paying dividends as there is more cash in the shareholder's hands at the end of the day. They're right!
Just above, I said you pay less tax with wages, and now I say dividends generate more cash for the shareholder. How can both be right?
Wages trigger the additional payment of CPP (Canada Pension Plan). For 2022, an employee's maximum CPP payment on wages over $64,900 is $3,500, and the company matches that. In total, that's a $7,000 investment toward your retirement.
Some people treat the CPP paid by the company and the individual as a tax. They say more taxes are paid on wages, so dividends are the better option.
In my view, CPP is an investment toward your retirement. If you are paying yourself dividends, you should invest an "extra" amount each year that equals the CPP amount you would have paid on wages.
I won't debate here whether that is a good or bad investment. The point is that you will benefit from this contribution in the future.
If you pay yourself dividends and invest the equivalent of the CPP into your investment portfolio, that will give you less cash flow than the wage option.
If receiving maximum cash is your primary goal, I still vote for wages as the option of choice.
I believe that "least tax" and "maximum cash" are not the only criteria you should consider.
Some other factors include:
I will discuss the above and more in upcoming posts issues.
You and your business are unique. There are no one-size-fits-all answers for us business owners. We have to figure it out for ourselves. That said, you don't have to do it alone.
We've carefully listened to business owners for more than 30 years. We've helped them resolve their issues and lessen their stress as their business ally.
Phil is a Partner at the business accounting firm of Zenally Chartered Professional Accountants LLP.
For more than 30 years, he has sat face-to-face with owners of businesses of all sizes. He has listened to them, helped them identify their issues, and provided guidance.
Business owners have left with answers to their questions, less stress moving forward, and confidence that they have a business ally to call on anytime they need.
Interested in finding out more about Phil, his team and what they can do for your business? Check them out at zenally.cpa.
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