Should You Earn your Income through Dividends or Through a Salary?

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When you are the owner of a business, there are two inevitable facts. First, you will either earn your income through a personal salary or through the issuance of dividends. Secondly, you must pay taxes on these figures either way. Still, there are different rates of taxation for each type of financial allowance. Depending on the size of your business, you current financial requirements, your future pension plans and if you expect your company to substantially grow into the future, there are different approaches that you will be able to take. Should you understand the specific characteristics of each option, you will be able to place yourself and even your family members in an excellent financial position. So, is there one way that is more preferable to the other? To answer this question, let us have a quick look at some of the advantages and drawbacks of each type of allowance in the simplest terms possible.

Although there are many deductions that will naturally be associated with earning a personal salary, there are other windfalls that are not found with dividends. For example, there are ample ways to earn a substantial amount towards your pension. Another advantage is what is known as an RRSP contribution. This allows you room to invest in certain pension products while simultaneously enjoying a reduction of your taxes incurred via present income. Another major concern is that a personal salary will allow for the deduction of child care expenditures. This is not possible with a dividend structure.

Choosing Dividend Payments
You may be wondering what the main benefits of dividends are and why these vehicles are so very popular. The primary windfall is that they experience much fewer deductions. Some examples of the payroll deductions that can be avoided are CPP premiums, EI Premiums and other personal taxes. So, a dividend structure can be viewed as one of the most direct ways for self compensation.

As dividends are taxed slightly different than a salary, you may also be able to reduce your aggregate income tax levels. Should other family members be involved you business, you can split income with these shareholders. Still, it is a good point to remember that you should avoid paying any family member that is under eighteen years of age these dividends. Should you be remiss in this, you may very well find yourself subject to what is colloquially known as the “Kiddie Tax”. In other words, you will risk placing yourself into a higher tax bracket (and therefore suddenly being responsible for paying higher levels of taxes).

While you may choose to be paid in dividends, a personal salary or a combination of the two, it is always best to speak with a tax adviser. He or she will provide the most relevant advice based off of your unique personal and financial requirements; thus allowing you to choose what may very well be the best option available.

Eric La CaraEric La CaraManaging Partner and Tax Practice manager for Capital Tax in Vancouver and Tokyo. Eric is a U.S. and Japan Personal & Corporate tax specialist with more than 15 years of experience in the area of cross-border structuring and taxation. Eric is charged with developing Capital Tax overall operations and strategic direction using the business and technical skills he has acquired during his professional career in Asia.