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How to pay yourself? Salary vs Dividends

Updated: Nov 3, 2023



Introduction


Small business owners often grapple with pivotal financial decisions, one of which revolves around their compensation structure. This dilemma centers on whether to opt for a conventional salary or dividends. These choices carry distinct advantages and drawbacks based on various factors. In this blog post, we, at SKG Financial Inc., shed light on the intricate nuances of salaries and dividends and offer expert guidance to empower you in making an informed decision.


1. Understanding Salary and Dividends


Before we delve into the finer details, let's establish a clear understanding of salary and dividends.


Salary: A salary represents a regular, predetermined payment disbursed by the business to its owner. This compensation is subject to payroll taxes, mirroring the structure of an employment contract, akin to any other employee's remuneration.


Dividends: Dividends are financial distributions allocated to the business owner as a proportion of the company's profits. These payouts are apportioned to shareholders, with the business owner being one such stakeholder. Notably, dividends evade payroll taxes, making them an enticing alternative.


2. Pros and Cons of Taking a Salary


Pros:


- Pension: Business owners can contribute towards their Canada Pension Plan (CPP) by paying themselves a salary.

- Tax Benefits: Business owners can reduce the company's taxable income by deducting the payroll costs from it, ultimately leading to reduced corporate tax liabilities.


Cons:


- Payroll Taxes: Salaries are subject to payroll taxes, potentially increasing the overall tax burden.

- Limited Tax Planning:** Business owners may confront constraints in fine-tuning their tax liability through the rigid structure of salaries.


3. Pros and Cons of Receiving Dividends


Pros:


- Tax Refund: Dividends are eligible for a special non-refundable tax credit, in recognition that the tax was already paid on the corporation’s income.

- Flexibility: Business owners enjoy enhanced flexibility in terms of timing and amount of dividend payments, lending itself well to effective tax planning.


Cons:


- No Guaranteed Income: Dividends are contingent upon the financial performance of the business. There may be periods where dividends cannot be distributed if the retained earnings balance is negative.

- Possible Double Taxation: In select jurisdictions, dividends may be susceptible to double taxation – initially at the corporate level, followed by individual taxation. In Canada, this is mitigated through various tax refunds.


4. Finding the Optimal Balance


Ultimately, the verdict concerning salary or dividends should be an outcome of a holistic evaluation encompassing your business's financial stability, your personal fiscal prerequisites, and the intricacies of your tax situation. Below are some pivotal considerations that can guide you toward achieving the optimal balance:


- Consult a Tax Professional: Seek counsel from a seasoned tax professional to gain comprehensive insights into the tax implications of your choice and to devise a tax-efficient compensation strategy. SKG Financial offers innovative tax strategies to effectively plan for minimizing your tax liabilities. Reach out to us at info@skgfinancial.com to get started.

- Evaluate Your Business's Financial Health: Prior to considering dividends, it is imperative to ensure your business is profitable and financially robust, given that dividends are contingent upon available profits.

- Strategize for Retirement: Deliberate on how your choice of compensation methodology aligns with your long-term financial objectives, particularly in the context of retirement planning.


Conclusion


Selecting between a salary or dividends as a small business owner is a nuanced decision that defies one-size-fits-all solutions. Each approach carries unique advantages and disadvantages, and it is imperative to conduct a comprehensive assessment of your specific circumstances. Striking the perfect equilibrium between salaries and dividends is instrumental in optimizing your income, minimizing tax liabilities, and achieving your financial goals. We strongly recommend enlisting the expertise of seasoned professionals to ensure an informed decision tailored to the unique needs of your business. At SKG Financial, we are committed to providing expert guidance for small business owners navigating the complex tax environment. We specialize in various industries including e-commerce, service-based businesses, and owner-operators.


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