SALARY OR DIVIDEND?
BY: JILL STAIRS, PARTNER, EPR DAYE KELLY & ASSOCIATES
Salary Or Dividend?
What Should You Choose?
Whether to draw a salary or a dividend is a challenging matter for incorporated business owners. A fundamental concept in Canadian income tax is that there should be no significant difference in total income taxes paid, regardless of form— salary or dividends. This preserves integration of the income tax system and prevents the occurrence of a rate arbitrage which could otherwise skew an owner’ s decision. Generally, incorporated business owners have a choice about the form of their compensation: take a salary as an employee or a dividend as a shareholder. Given the recent changes in tax rates, both federally and in New Brunswick, it is worthwhile for business owners to revisit their compensation model if they have not done so in a number of years.
In 2016, the income tax rates in New Brunswick reflect that there is no cost of incorporation on corporate earnings in excess of $ 500,000. However, the owner has to ensure distributions are designated as eligible dividends to receive this result. For corporate earnings subject to the small-business tax rate, there is a 1.6 percent cost to incorporation. Keeping active business earnings within the corporation( i. e., taking no salary or dividend) results in a significant deferral of personal income taxes: 39.3 percent for corporate earnings under $ 500,000 and 24.3 percent for corporate earnings in excess of $ 500,000.
Taking a salary means contributing to the Canada Pension Plan( CPP) as both an employer and an employee, with a cost of around $ 5,000 a year to obtain maximum CPP benefits in retirement. Furthermore, salary generates contribution room for Registered Retirement Savings Plan( RRSP) purposes. In contrast, a shareholder opting to just receive dividends preserves cash by avoiding the CPP contribution. Where no employment income is earned, no RRSP room is generated and lower CPP benefits will be received in retirement compared to someone who contributes to CPP throughout his or her employment. In 2016, to receive maximum CPP benefits, an employee needs to earn a salary of $ 54,900. To maximise RRSP contribution room, a $ 144,944 salary is required. These amounts increase annually because of indexation. These are some, but not all, of the considerations for choosing one form of compensation over the other.
Typically, owners can use shares of the corporation that legally owns the family business as a way to provide for additional flexibility in their family compensation strategy. For an individual with a spouse and adult children, providing share ownership to them allows for dividends to be sprinkled to persons in lower tax brackets, achieving family income splitting. The end result is often a reduction in the overall effective tax rate for the household which ultimately maximizes family wealth.
There are a number of legal, tax and other considerations to factor in when developing a compensation plan. It is important to work with knowledgeable advisors to ensure a strategy is in place, it is revisited frequently and it continues to be current to meet the owner’ s objectives. +
Jill Stairs is a partner with EPR Daye Kelly & Associates in Fredericton, New Brunswick.
26 | FALL 2016