Shareholder Remuneration: Wage or Dividend
A very common question asked by small business shareholders is “Should I compensate myself with wages or dividends?” The answer is more complex than simply the overall tax implications.
Let’s begin by looking at the most basic difference between the two. Wages are an expense to the corporation, thus reducing profit and related corporate income tax expense. Dividends are not an expense to the corporation and are paid from after tax earnings of the corporation. There are a number of factors to consider in the wage versus dividend decision.
Corporate tax - As mentioned, wages are an expense that reduces corporate profit and thus reduces corporate tax. Dividends are not an expense, and therefore corporate tax paid will be higher under the dividend option. The current combined provincial and federal corporate tax rate on active business in British Columbia for corporations qualifying for the small business deduction is 12% for income after January 1, 2018.
Personal tax - Income earned from wages is taxed at a higher personal rate than income earned from ineligible (regular) dividends. In 2018 the tax rate on wage income in the highest personal income bracket (> $205,842) is 49.80% compared to the top bracket rate for regular dividend income of 43.73%.
Canada Pension Plan (CPP) – CPP contributions are payable on wage income. In 2018 the maximum pensionable earnings for CPP is $55,900 for a combined self-employed maximum annual contribution of $5,187.60 (both employee and employer portions). While this does bring about a cash flow consideration, CPP can be a good retirement planning tool especially for those not likely to save and plan for retirement on their own.
RRSPs – Wage income creates RRSP contribution room, while dividend income does not. The annual RRSP contribution room is calculated on 18% of the previous year’s wage earnings. Unused amounts are carried forward to the next year and accumulated. In 2018 the limit is $26,230, which is 18% of $145,722.
CNIL – For taxpayers with a cumulative net investment loss (CNIL) balance, paying dividend reduces the balance so more of the capital gains deduction can be accessed in the event of a sale of qualified shares.
Reporting – A CRA payroll account must be in place for wage income, source deduction remitted regularly and a T4 filed by the last day in February. For a corporation with other employees, adding the shareholder to payroll is not much of a burden; however, for a corporation with a single shareholder and no other employees, the additional calculations, remittances requirements and reporting could be a consideration. Dividend income on the other hand is reported on a T5 Slip by the last day in February and there is no payroll account to maintain or source deductions to submit. You are, however, required to make personal tax instalments if your prior year income tax owing is $3,000 or greater. This is more likely to be the case with dividend income, as regular remittances are not being made.
Work Safe BC Premiums – Premiums must be paid on all shareholder wage income up to the max assessable earnings amount, which is $82,700 in 2018. No exception. Work Safe BC premiums are assessable on dividend earnings only to the extent that dividends are paid for active work in the corporation.
Combined Income Tax - From a straight income tax perspective, let’s look at a scenario comparing the total tax paid under the wage versus dividend option.
Assume a corporation is a CCPC, qualifies for the small business deduction, and has $10,000 of income. The shareholder is trying to decide between paying a wage or paying corporate tax on the $10,000 and then paying a dividend with the remaining balance. Which of the two options results in the most after-tax dollars for the shareholder?
If the shareholder is in the top income bracket they will end up with $5,020 after tax dollars under the wage option and $4,952 under the dividend option. A difference of only $68. Under the same scenario, only for a shareholder in the lowest tax bracket (>$39,676) the difference between the choices is a mere $6 in favour of the wage option.
These are just a few of the factors to consider, and as you can see there is not a one size fits all solution. In many cases a combination of wages and dividends may be the best strategy.
This article is for general information purposes only. You should discuss your specific situation with a qualified professional.