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This article is written for business owners who have incorporated their business. Once you incorporate, you’ll discover that you have to decide how to pay yourself, your family and your shareholders, and you’ll need to understand dividends vs salary.
If your business is not incorporated, whether or not you pay yourself a “salary” is irrelevant for tax purposes because you and your business are considered a single entity by the CRA. You cannot pay yourself dividends unless you are a director and/or shareholder of an incorporated entity. If you are not incorporated, skip ahead to “Paying your team: Contractors vs Employees.”
As an incorporated small business owner, you’ll pay your non-shareholding employees through payroll with a salary or hourly wages. As a shareholder, you have the additional option of paying yourself and other shareholders through dividends. Choosing how to pay yourself and other shareholders can be tricky, and it has significant tax and other implications. You should definitely seek the advice of your accountant and ask them to run scenarios of the various options before making a final decision.
Below we will cover the basic difference between dividends and salary. Here’s how each payment option works:
All salary payments and payroll burdens (employer EI, and CPP), are deductible labour costs — expenses to your corporation and therefore tax-deductible. If you’re paying yourself, remember that these payments are personal income, so you’ll pay personal income tax on them.
You’ll have to register a CRA payroll account to disperse salaries, and record, withhold and remit CPP and EI deductions to the CRA. Salary payments for payroll require you to generate T4s for anybody working for your corporation (including yourself). The majority of payroll software will generate these T4 slips on your behalf.
Dividends go to your shareholders and they are after-tax payments (not expenses) that don’t reduce your corporate tax payable. You can only declare dividends to the same extent a shareholder is invested in a single class of shares in your company. For example, someone with a 50% share of Class A common shares would get 50% of the dividends you pay out to Class A shareholders.
However, if you created different classes of shares when you incorporated, you can use the different classes to enable a targeted allocation of dividends to shareholders. One common approach used by entrepreneurs is to create a different class of shares for each family member they might wish to disperse corporate income to. So if you have 5 family members, including yourself, you might create classes A, B, C, D, and E and allocate one to each family member.
Corporations pay dividends at various frequencies, from once to many times per year. Dividend payments for payroll require you to generate T5s for anyone that received dividend payments.