Most entrepreneurs face this question sooner rather than later in the development of their company. Usually, you need enough salary to cover your personal expenses (rent, mortgage, food etc.) However, it can get tricky when trying to determine the best way to take money out of your corporation.
When you take money out of the organization there is no specific classification until you make one with the CRA. Funds that are drawn out can be treated as a loan, but these will need to be paid back to the company and can create their own tax implications.
Generally there are two different ways to classify payment to yourself: salary and dividends. Let’s explore the salary option first.
When paying yourself a salary from your company, it is treated a tax deductable item. That means that if your corporation made $25,000profit and you issue yourself a salary of $25,000, the corporation has a net income of zero. This results in not having to pay any taxes at the corporate level.
However, the $25,000 will be added to your personal income and will be subject to the federal and provincial tax rates. In addition, taking a salary can create some added administrative work since you will have to open up a payroll account and make additional payroll remittances for E.I and CPP on behalf of your company. These are in addition to the amount that will be paid on the salary by you personally.
Some advantages of issuing a salary to yourself are that you get to contribute to CPP which can benefit you later on in retirement and that issuing yourself a salary helps to increase your RRSP deduction limit which can help you defer and reduce income taxes if contributions are made. Having a salary may also allow you to take advantage of other tax credits that a dividend may not.
Unlike a salary, a dividend is not a tax deductible item. Using our example from above if the corporation has $25,000 in income and there is a $25,000 dividend declared, there is no impact on net income. As a result, income tax will have to be paid by the corporation at the federal and provincial rates.
On the personal side, you will also have to include $25,000 in dividend income in your tax return. However, CRA understands that you are being taxed in the corporation and personally in this scenario so they have favourable tax rates for dividend income. An individual can almost take up to $50,000 in dividends without having to pay any tax personally if they do not have any other income.
On the administrative side, dividends are easier to manage for your corporation. The corporation simply has to declare the dividends in their corporate minute books and file a T5 return for the amount of the dividend.
What is best for you?
Everyone is in their own unique tax situation and you do not necessarily have to choose one or the other. You can take out money from your corporation using both a salary and a dividend to take advantage of your personal situation. I often get asked what is the best ratio of salary to dividends for someone to take? The honest answer to the question is that it is unique for everyone. However, one thing is for certain, spending time to determine the best ratio of salary to dividends to take can help you save lots of money. The calculation can get tricky, and in order to optimize your income tax position it is best to consult with your tax accountant.
Image credit: By Duckie Monster via flickr.com.