Salary versus Dividend for an Owner-Manager

Why simple online comparisons are often wrong

A salary and a dividend are not paid from the same tax base. Salary is normally an expense to the corporation, subject to reasonableness and payroll requirements. A dividend is paid from corporate after-tax income. Comparing a $75,000 salary with every dollar of cash that remains available for dividends is not an equal comparison.

A proper model starts with the same corporate income before owner compensation and the same desired owner cash. It then calculates corporate tax, employer payroll costs, personal tax and retained corporate cash under each option.

Worked example using equal economic assumptions

Assume an Ontario corporation has $120,000 of income before owner compensation and the owner wants approximately $70,000 of personal cash.

Under a salary approach, the corporation deducts salary and employer CPP before calculating corporate taxable income. The owner pays income tax and employee CPP. Under a dividend approach, the corporation first pays corporate tax and distributes part of the remaining cash. The owner reports a grossed-up taxable dividend and claims the applicable dividend tax credit.

The correct result cannot be stated from the $120,000 figure alone. It depends on whether the dividend is eligible or non-eligible, the owner's other income, available deductions and the corporation's tax profile. The model should display corporate cash left after both scenarios so the owner can see whether one option quietly withdraws more value than the other.

Reasons to choose salary even when current tax is slightly higher

Salary creates RRSP contribution room, supports CPP participation and produces employment income that may be useful for financing applications. It can also help create a consistent personal cash-flow pattern. Payroll deductions and remittances create administration, and the corporation bears employer CPP.

Salary may be especially useful where the owner wants retirement savings room, expects to rely on CPP, or needs documented recurring income for a mortgage. It may also help reduce corporate taxable income before year-end when properly accrued and paid within the required period.

Reasons to choose dividends

Dividends do not attract CPP and are administratively simpler than payroll once the corporation has sufficient legal and tax capacity to declare them. They may suit an owner who already has adequate pension or retirement assets, does not value additional RRSP room and wants to avoid CPP costs.

However, a dividend does not create RRSP room and is not deductible to the corporation. The owner should not treat bank transfers as dividends without corporate resolutions, correct bookkeeping and confirmation of the dividend type.

A blended strategy

Many owner-managers use a combination. For example, the corporation may pay enough salary to create desired RRSP room or support financing, then use dividends for additional withdrawals. Another owner may draw a base salary throughout the year and declare a year-end dividend after results are known.

The blend should be designed before T4 and T5 reporting deadlines, not reconstructed from random shareholder withdrawals. Amounts already taken personally should be reconciled to payroll, dividends, reimbursements or shareholder loans.

Decision checklist

Before finalizing the mix, confirm:

• corporate income before compensation;
• the owner's other income and deductions;
• whether dividends will be eligible or non-eligible;
• CPP value and cost;
• desired RRSP room;
• cash needed personally;
• cash required inside the corporation;
• shareholder-loan balances;
• financing or benefit considerations; and
• payroll and corporate-law documentation.

The lowest combined tax in one year is not always the best long-term choice. Retirement benefits, borrowing capacity and retained business cash may justify a different result.