Introduction
You need to declare a remuneration but aren’t sure whether you should declare it as a salary or as a dividend?
In essence, a salary is an employee’s payment for their work, while a dividend is a shareholder’s payment for holding shares. However, if you are both an employee and a shareholder, you can choose to declare income as one or both options to optimize your tax potential.
Before we discuss tax optimization, let’s first take a look at the differences between corporate and individual taxation, so you can see the areas for optimization.
In theory, the Canadian tax system integrates both corporate and individual taxation. Therefore, if you earn $1000 as an individual and declare it, the amount you are left with will be the same as declaring your income as a corporate entity.
Depending on your financial situation at both the corporate and individual levels, declaring your income as a salary or a dividend can have unique benefits.
Corporate Taxes
Before getting into the benefits of declaring a salary vs a dividend, let’s first discuss how corporate taxes work in Canada.
In Quebec, corporations pay taxes at both the provincial and federal levels.
Federal Corporate Taxation in Canada
Without going into too much detail, a Canadian Controlled Private Corporation (CCPC) will pay a federal tax rate of 15%.
Thanks to the Small Business Deduction (SBD), the first $500,000 of income is eligible for a tax reduction.
The SBD is a tax measure that allows CCPCs that are active and operating in Canada to take advantage of a reduced income tax rate.
To keep things as simple as possible, for now, we won’t get into taxable assets.
Provincial Corporate Taxation in Quebec
In Quebec, the corporate tax rate stands at 11.5%.
For companies that operate in the primary and secondary sectors or have paid over 5,500 hours of salaries to employees, the tax rate is reduced to 3.2% for the first $500,000 of taxable income.
Combined Corporate Taxes
The combined tax rates at the federal and Quebec levels are:
On the first $500,000 of taxable income (income minus expenses):
• Canada: 9%
• Quebec: 3.2%
• Total: 12.2%
On taxable income exceeding $500,000:
• Canada: 15%
• Quebec: 11.5%
• Total: 26.5%
Why You Should Declare a Salary Instead of a Dividend?
Even though you will be taxed at a higher individual rate, there are several advantages to declaring income as a salary rather than a dividend. These are:
Increased RRSP Limits:
The maximum amount you can contribute to your RRSP depends on your eligibility and limits. These are indicated in your federal Notice of Assessment. The limit corresponds to 18% of your earned income from the previous year, or the annual limit for the current year. For 2023, this is $30,780. Salary is considered earned income, whereas dividends are considered passive income. So, by declaring your income as a salary, you increase the maximum amount you can contribute to your RRSP.
The corporation has a taxable Income greater than $500,000:
As mentioned, when a company has a taxable income (income minus expenses) of over $500,000, that company is subject to an increased tax rate. Paying salaries over a certain amount will reduce your company’s tax rate. Therefore, each $100 of salary can save your company $26.50 in taxes. This corresponds to a tax saving of 26.5%.
R&D/SR&ED, E-commerce and Multimedia Tax Credits:
If your company actively participates in Research & Development, and you are involved in this work, it’s better to declare your income as a salary. This is because dividends do not count as R&D expenses.
You need 6 eligible employees to benefit from the E-commerce tax credit. If you have below this number, and you are eligible as an employee, you should declare your income as a salary. By doing this, you become an eligible employee and your company can benefit from E-commerce tax credit.
A salary is an expense for the Multimedia tax credit, while a dividend is not an eligible expense.
Improved Family Planning:
If you have or plan on having children, it’s better to declare your income as a salary. This is because it will allow you to take advantage of the Quebec Parental Insurance Plan (RQAP) when your children are born or adopted. In 2023, the maximum insurable earnings under RQAP are set at $91,000.
Deductible Childcare Expenses and Benefits:
If you declare income as a salary, your childcare expenses are considered deductible income. If you declare your income as a dividend, this is not possible.
For the purposes of calculating your taxable income, depending on the kind of dividend, you must gross up the amount you received by 15% or 38%.
Declaring your income as a dividend increases your total income, and this amount is used for the calculation of the Canada Child Benefit (federal) and the Family Allowance (Quebec) to determine your childcare benefits. Therefore, declaring your income as a dividend can reduce your available benefits overall.
Decreased Quebec Corporate Tax Rate:
In Quebec, the corporate tax rate changes depending on the minimum hours worked by every employee in a company. If you haven’t reached the minimum threshold for hours worked, you should declare your income as a salary. In this case, you can reach the threshold and qualify for a decreased tax rate.
Financial planning:
When it comes to borrowing for a mortgage or personal loan, institutional lenders take into account your taxable income and credit history. They have strict criteria when determining your eligibility and ability to pay back a loan, and use declared income for this purpose. However, a dividend isn’t counted as regular income in this case, so lenders do not factor it into your financing eligibility.
Why You Should Declare a Dividends vs Salary
On the other hand, there are several benefits to declaring your income as a dividend instead. These are:
Decreased Individual Tax Rate:
Usually, for individuals, the tax rate for dividends is lower than that for salaries.
Deductible Financial Expenses:
Since a dividend is considered investment income in Quebec, declaring your income as a dividend will allow you to deduct financial expenses from your total taxable amount.
Corporate taxable Income Below $500,000:
If your company already pays corporate tax at the lower rate of 12.2%, there isn’t as much benefit to declaring income as a salary.
Decreased Benefits Expenditure:
On average, the cost of employee benefits amount to 13% of a company’s salary expenses. So, if a company pays $10,000 in salary, with benefits added, the total expenditure will be $11,300. By paying a dividend instead, you save on the expenses associated with employee bonuses and benefits.
No CorporateTaxable Income:
If your company doesn’t have a taxable income, there is little point in declaring your income as a salary as you won’t get any decreased taxes or other benefits in the corporation. In this case, it may be more advantageous to declare it as a dividend.
Declaring Income as Both Salary and Dividend
Based on your situation, we may have some benefits to declaring part of your income as a salary and part as a dividend. For example, if your company earns below $500,000, you can declare a portion of your income as a salary to maximize your RRSP contribution and be eligible for childcare expenses deductions. The remaining income amount can be declared as a dividend to reduce your individual tax rate and decrease the costs of employee benefits.
Remember, you will also need to consider your spouse’s income and your family situation.
In Conclusion…
When it comes to optimizing your taxes, salaries and dividends have their own advantages and disadvantages. Take your time and consider all the options available to you to determine what’s best for your individual situation and your business. As always, when it comes to taxes and tax planning, there is no definite answer. Instead, the best course of action depends entirely on your personal situation.