Salary vs Dividend - The Age Old Debate (Part 2)

In Part 1 of the Salary vs Dividend series, we discussed the fundamentals of salary vs dividends and the concept of tax integration.

In this article, we’ll discuss when salary may be preferred, when dividends may make more sense, and one novel idea: withdrawing nothing at all.

See Part 1 here.

Option #1 — Salary

In Part 1, we discussed some of the key benefits of salary (e.g. RRSP room, CPP entitlements, corporate tax deductions, etc.)

Additional reasons salary may be preferred:

• Taxes are withheld automatically, helping avoid large personal tax balances owing at filing time.

  
  

• Child care expense deductions are generally limited by the lower-income spouse’s “earned income.” Earned income includes salary, but not dividends.

  
  

• If you still have tuition tax credits available, dividends may be less efficient. Due to how tax credits are applied, tuition tax credits are generally used before dividend tax credits, which can “waste” your tuition tax credits.

  
  

• Lenders generally prefer stable salary income over dividends.

Option #2 — Dividends

Additional reasons dividends may be preferred:

• Active business income above $500,000 is generally taxed at a higher corporate rate (~26.5% in Ontario instead of ~12.2%). These excess profits can generally be distributed as “eligible dividends,” which are taxed at lower personal tax rates than salary and regular dividends.

  
  

• If the corporation has a Capital Dividend Account (“CDA”) balance, dividends may be beneficial since CDA dividends are received tax-free personally.

  
  

• Passive investment income earned in a corporation can initially be taxed at rates exceeding 50%. However, majority of this tax can be refunded when taxable dividends are paid to shareholders.

Option #3 — Leave Funds Inside the Corporation

This is the option many business owners overlook.

Sometimes, the most efficient strategy is simply to withdraw less personally and retain excess funds inside the corporation for investing. This strategy works best if you have available personal funds or a partner that can support living expenses.

This can work particularly well where investments are not RRSP or TFSA eligible, such as:

• Real estate

• Private investments

• Alternative investments

• Business acquisitions

For example, active business income earned in an Ontario corporation may initially be taxed at approximately 12.2% (expected to decrease to 11.2%), creating a significant tax deferral opportunity where funds remain invested corporately instead of being immediately withdrawn personally.

Of course, retaining funds corporately also introduces additional considerations including passive investment income rules, corporate investment taxation, creditor protection, and eventual extraction planning.

Key Takeaways (Part 2)

The best compensation strategy is usually the one that aligns with your long-term financial and tax planning objectives.

Final Thoughts

If you are unsure how you should be paying yourself, I am happy to provide a second opinion.

Warm regards, 

Francis Do, CPA, CA

Have any questions? Please contact Francis Do at Francis@francisdo.com or 416-572-9633.