As the owner-manager of an incorporated business, you can choose how you wish to be compensated: By receiving a salary (including bonuses) or through dividends from shares you own in the company — but there are a number of factors to consider before you make that choice.
Salary: Is a deduction to your company but will also attract both employer and employee Canada Pension Plan (CPP) premiums and, in some provinces, payroll taxes.
Generates Registered Retirement Savings Plan (RRSP) contribution room, CPP benefits and is necessary if you wish to establish an Individual Pension Plan (IPP).
Dividends: Are paid out of after-tax corporate profits; Corporate business income in excess of the small business deduction (SBD) limit ($500,000 federally and in most provinces) is subject to higher corporate tax rates than business income eligible for the SBD. Dividends paid out of business income above the SBD are eligible for a more advantageous personal tax rate. Dividends paid out of business income taxed at the lower SBD rate are non-eligible, resulting in a lower Dividend Tax Credit for the shareholder and, consequently, attracting more personal tax than an “eligible” dividend.
A mix of salary and dividends: In the past, tax professionals often advised business owners to pay themselves at least enough salary to reduce corporate profits below the SBD limit, to avoid higher rates of corporate tax on active income. But, with the drop in corporate rates, more tax can now be deferred by leaving income in the corporation – so, if corporate income will not be needed personally, it can make sense to retain high tax rate income inside the corporation for investment. However, to the extent that you require cash on a regular basis, salary is often the preferred compensation choice until corporate income is reduced to the SBD limit.
A pure dividend strategy: Taking compensation solely as dividends means that you will not be able to build RRSP room, may jeopardize access to CPP disability benefits and may not qualify for group disability plans. This strategy can, however, allow more income to be saved inside the corporation than could otherwise be contributed to investments held within a RRSP or an IPP and could more than offset the reduction in future CPP retirement benefits. But this is a complicated strategy that requires consultation with your professional advisors.
Creditor protection – many provinces have rules preventing professional corporations from using holding companies or trusts as creditor proofing strategies so it may be prudent to hold a significant portion of retirement assets in registered IPPs or Guaranteed Income Funds (GIFs).
Compensation planning is closely linked to retirement planning. Addressing these issues now will improve your ongoing financial stability and retirement nest egg. Your professional advisor can help make the best choices for you.
Andy Erickson is the division director with Investors Group, Vernon. This article is provided for information purposes only. Please consult with a professional advisor before implementing a strategy.