Paying Yourself Dividends – Pros and Cons

21 February, 2008 (12:21) | Corporate Tax, Personal Tax, Small Business Tax | By: Cecilia Leung

This method is used by a lot of business owners, directors and other board members, since they are investors of the business.

What is Dividend?
Dividend is the return on investment from the business you invested in. There are two types of dividend: eligible and other than eligible dividends.

What is Eligible Dividend and Other-than-Eligible Dividend?
Legislative Proposals on Dividend Taxation issued in year 2005 provides the following definition in subsection 89(1) stated:

“eligible dividend” means a taxable dividend that is received by a person resident in Canada, paid after 2005 by a corporation resident in Canada and designated, as provided under subsection (14), to be an eligible dividend;

and subsection (14) states:

A corporation designates a dividend it pays at any time to be an eligible dividend by notifying in writing at that time each person or partnership to whom it pays all or any part of the dividend that the dividend is an eligible dividend.

Simply put, it is dividend paid after year 2005 from a Canadian public company or Canadian-controlled private company to Canadian residents. Any other dividends are considered “Other-than-Eligible”.

Eligible dividend: Fed tax credit : 18.9655%
Non eligible: Fed tax credit: 13.3333%

Pros

You don’t need to go thru payroll process throughout the year. Simply calculate how much you draw from the company at the end of the year as dividend.
Dividend tax credit can be applied in your personal income tax return
Dividend income is your taxable income, hence your RRSP room will increase
Since you have income, your personal credit are also improve when you go for a loan from most financial institution
It is more flexible on how much you draw from the company

Cons

Dividend distribute to owners are after tax money.
Dividend you received from the company is taxable as investment income.

So you pay double tax, why do you want to even pay yourself dividend then? You don’t really pay double tax. The Canadian federal government apply tax cut to dividends. In year 2006, the federal government has even cut more tax on some dividends a person received.

Here’s how it is calculated:
Note: Using rates from year 2007 taxation year

For eligible dividend:
Taxable amount = 45% more than the dividend amount (dividend amount * 1.45)
Dividend tax credit = 18.9655% of the taxable amount

For other-than-eligible dividend:
Taxable amount = 25% more than the dividend amount (dividend amount * 1.25)
Dividend tax credit = 13.3333% of the taxable amount

Example:
If dividend you paid is $10,000 and it is eligible dividend

For eligible dividend:
Taxable amount = $10,000 * 1.45 = $14500
Dividend tax credit = $14500 * 18.9655% = $2749.9975

Amount of tax you need to pay for this income as dividend:
For eligible:
Taxable Income * tax rate – Tax credit = $14500 * 15% – $ 2749.9945 = (574.9945)
You get back $574.99 tax refund

Amount of tax you need to pay for this income as salary:
Taxable Income * tax rate – Tax credit = $10000 * 15% – $0 = $1500
You pay $1500 to the government

Using the tax rate of 2007 an assume you are in the lowest tax bracket

As you can see in the example, if you are in low income and apply 15% tax rate, and you have 18.9655% tax credit, you will actually get money back. If you pay yourself salary, you will be paying $1500 on tax.

Using the above example, if you are in a higher income tax bracket:
If you pay salary of 10,000, you will need to pay $2200 to the government. If you pay yourself 10,000 as dividend, you will pay $440 (14500 * 22% = 3190 – 2749.9945 = 440.005).

Since the company already paid tax, and company tax rate are lower than the individual tax rate, this tax amount is to offset the extra tax you owe the government between the company and personal tax. This is to avoid double tax.

So in the end, if you are a small business owner and you draw money out to yourself, there is not much different on how much tax you pay to the government.

Comments

Pingback from T5 Penalties and Interest
Time February 27, 2008 at 12:06 pm

[...] Sites ← Paying Yourself Dividends – Pros and Cons Filing T5 – Paying Dividend [...]

Comment from Taxes Nerd
Time February 25, 2009 at 9:37 pm

Hey Cecilia Leung,

The word “LARGE” is missing in your statement, it is misleading to non-accountants. It should read as “eligible dividends” paid to individuals by LARGE corporations. To explain, that means a public corporation or CCPCs taxable at a general rate of 22%.

Comment from janoubie
Time September 6, 2009 at 2:55 pm

Hello Cecilia,
if I have net profit at the end of my fiscal year can i still pay my self salary and then still claim it as payroll expense on the previous year. thanks

Comment from Cecilia Leung
Time September 18, 2009 at 9:19 pm

I am not sure if I understand what you are asking exactly. Assuming your fiscal year has passed and you have net profit, you would not want to pay those as salary and claim them as payroll. Payroll follow rules that you have to pay every month and those are your payroll expenses, otherwise penalty and interests will be charged. Let me know if I misunderstood your question.

Comment from janoubie
Time September 19, 2009 at 2:04 pm

I HAVE LEARNED THAT YOU CAN PAY YOURSELF A BONUS WITHIN 180 DAYS FROM YOUR FISCAL YEAR END TO REDUCE PROFIT IS THIS TRUE

Comment from Cecilia Leung
Time September 20, 2009 at 3:00 pm

Hi jaonubie,
You can pay yourself bonus within the fiscal year and therefore this bouns is you business expenses, and therefore it reduce your business profit. However, you have to report payroll during the fiscal year on your bonus to become part of your business expenses for that fiscal year. Any bonus you give after year end will count towards your next fiscal year. Also, depends on the amount of the bonus, it can be tax more then regular salary. Any salary, or bonuses you pay to yourself does reduce your business profit, but you also need to consider how much personal income tax you need to pay after you give yourself those income.

So to answer your question if this is true, no it is not.
For Bonus information you can go to http://www.cra-arc.gc.ca/E/pub/tg/t4001/t4001-e.html#P877_94827

Hope this help
Cecilia

Comment from Twila
Time September 27, 2009 at 2:21 am

If you’re paying yourself via dividends from your corporation but you also have other self-employment, does it make more sense to claim most of your business expenses on your T1 return for your self-employment, and pay a larger dividend from your corporation? For example, if my corporations gross was $49,000 but after I claimed “all the allowable expenses” the net was $32,000, would it make more sense to pay all of that in dividends and claim that along with my self-income, or would it make more sense to use as much of my expenses on my self-emplyment T1 claim and just pay out more dividends from my corporation? Or maybe I’m completely naive! First year filing a T2. I tried working them both out to see what was my best alternative.

Comment from Cecilia Leung
Time September 27, 2009 at 11:58 am

It make sense to pay most of your business expenses on your self-employed income, since self-employed income tax rate is higher than corporate tax rate. However, do not pay large dividend from your corporate, pay yourself only what you need for personal expenses, and leave the rest in the business. If you are in Ontario, paying dividend to save tax will not save you tax comparing to other ways to pay yourself. Starting in Jan 2009, the Ontario small business tax rate increased from 5.5% to 8.5%, on top of that with the tax you will need to pay on your dividend income as an individual, you may actually need to pay more paying yourself dividend, comparing to paying yourself as self-employed or salary.

Hope this help
Cecilia

Comment from wise
Time September 28, 2009 at 1:47 pm

The Canada Revenue Agency (“CRA”) allows a corporation to write off a management or shareholder bonus payable in the year of the accrual, provided it is paid out within 179 days from the corporate year-end.

If the bonus if not paid out within 179 days, the accrual is denied and the CRA will add the bonus back to corporate income. The bonus would then only be tax deductible during the fiscal year in which it was paid.

If a corporation’s year-end falls within 179 days of the calendar year, a bonus payable may provide for a tax deferral.

Comment from Cecilia Leung
Time September 30, 2009 at 5:52 pm

Hi wise,
Thank you for pointing this out. Yes you can pay yourself management fee as well, and with your strategy you can achieve tax deferral, just remember that one will need to pay the taxes at the end. However, management fee is often a subject of scrutiny, and it is definitely not something one can DIY. Corporation usually pay shareholders management fees to bring down their corporate revenue so that they reach the “small business deduction” eligibility limit. It is also commonly used to pay foreign shareholders for Canadian private corporation. Most of the time the combined fed tax and provincial tax are higher than the tax rate in the foreign country. I personally have never suggested my small business clients to achieve tax deferral, as there is a much higher chance for the corporation to be audited.

Here is a good article on this subject on the financial post regarding management fee:
http://www.financialpost.com/magazine/story.html?id=2016683

Comment from Feisal Visram
Time December 10, 2009 at 4:44 pm

Hi Cecilia-

Just want to ask why should someone use dividends, bonuses etc. to record payouts to themselves out of their corporation.
Since there does not seem to be a tax advantage (total tax paid by corporation and personal tax by 1 person who owns his own corporation) in using Dividends,
Bonuses etc. is it not easier to just pay out salaries?

The total tax you will pay will be the same regardless of which method you use to record cash distributions to yourself, I would select the easiest method and probably use salaries.
The only advantage of issusing dividends is that you don't have to fill out the payroll slips and submit them every week.

Any comments or suggestions?

Is there a tax advantage to paying part of the profits as dividends and the rest as salaries?
thanks.
Feisal Visram

Comment from Cecilia Leung
Time January 2, 2010 at 3:19 pm

Hi Feisal,
The main reason is that if you haven't remit any payroll remittance but you have draw money for personal use. This situation often happens when a new small business started. While the new and inexperienced business owner busy trying to get the business going, they often lack the knowledge on taxation or payroll matters. Hence at the end of the calendar year when a T4 needs to be issued, they realized there are more than just issuing a T4 to themselves. If they do issue a T4, they will be surprised to get a huge penalty and interests bill from the government on late remittance. In this case, the other choice is to issue yourself dividends.

Hope I answer your question.
Cecilia

Comment from jeanne
Time January 17, 2010 at 2:12 am

Hi, Cecilia Leung:

Thank you very much for the information provided by you.

Please let me know that the dividend from CCPC paying federal tax with 13.333% (I remember the total tax (fed and provision) for 2008 is below 19%) should belong to non-eligible dividend with tax credit 10000*1.25*13.3333% for 10000 dividend.

Thanks again,
Jeanne

Comment from georgegordon
Time March 4, 2010 at 6:23 pm

Hi Cecilia

Reading your comments/advice I'm more confused than ever?
I'm about to start a professional corporation since I'm sick end tired of paying $40000
$ 50000 /year as self -employed professional.
Here's the catch! My acountant ( of 7 yrs) adviced me to pay myself dividends instead of salary or bonuses. Based on his calculation , since I'm estimating a taxable corporate income of $185000 – $ 13000 extra pay for my non voting shareholders ( family members) I have to pay $28380 to CRA, having left with $143620 of dividends , wich triggers an additional $ 26600 tax on dividends to CRA The total tax that I'm paying in this scenario is $55000 – as corporation vs $ 64150 as self employed professional. Saving me almost $9000.
So either my acountant is not corect or your stament that paying dividends vs salary has no advantages , is not corect.

Thank's

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