Should an entrepreneur pay themselves through dividends or a salary?

Entrepreneurs have the option of paying themselves a salary or dividends

This article will help you make the right choice by providing information on these two methods of receiving income.

What are the benefits of paying yourself a salary?

A salary is compensation paid in exchange for work performed under an employment contract. It is treated as an expense in the business’s financial statements.

If you choose to receive a salary as an entrepreneur, these payments are first treated as business expenses before becoming employment income for you. This means you’ll receive a T4 form for your tax return. In addition, this expense reduces your company’s taxable income, resulting in lower corporate income tax liability at the end of the year.

To pay yourself a salary, your business must set up a payroll system registered with the CRA and Revenu Québec. With each payment, source deductions (pension plan contributions, income tax, etc.) must be withheld from your salary and remitted to the appropriate tax authorities.

In the industry, it is generally estimated that it costs an employer about $58 to pay a worker a gross salary of $57, while the employee receives between $35 and $40 net after source deductions.

Paying yourself a salary ensures a stable and predictable personal income. In addition, it allows you to contribute to an RRSP, claim tax deductions for certain services such as child care, and makes it easier to qualify for a mortgage thanks to a regular and predictable income.

Finally, income tax is withheld at the source from each paycheck, thereby avoiding a tax bill at the end of the year.

What are the drawbacks of paying yourself a salary?

The main drawback of a salary is taxation. In fact, a shareholder’s income is subject to a high tax rate, reaching 49.97% in Quebec. It is therefore important to manage your tax obligations carefully if you choose this option.

What are the benefits of paying yourself a dividend?

Dividends represent a portion of net profits distributed to a business’s shareholders. Unlike a salary, they do not reduce the business’s taxable income.

There are two types of dividends: fixed dividends and ordinary dividends. Dividends are taxed at a lower rate than wages for individuals under personal income tax laws because they qualify for a dividend tax credit.

Paying dividends to shareholders is relatively simple, and they are reported when funds are transferred from the business to the shareholder’s personal account.

What are the implications for the business?

Each year, the business must prepare and file T5 forms for shareholders who have received dividends. Ordinary and specified dividends are not deductible for corporate tax purposes. Individual income tax rates are therefore generally lower than those applicable to wages.

Paying dividends allows business owners to withdraw funds from their business without having to contribute to the QPP, which reduces costs for both the business and the shareholder.

When should an entrepreneur choose a salary over dividends?

Choosing how to be compensated is an important decision.

Now that you’ve reviewed this information, you have a better idea of the strategy to adopt as an entrepreneur.

Because of the impact on your financial well-being, we recommend that you consult a qualified accountant for assistance.

So don’t hesitate to contact us if you’d like to find an accountant who understands your unique business situation and can guide you through this process. https://www.bankeo.ca/