You're incorporated. Money is sitting in your corporation. Now the question: how do you actually get it into your hands? The two main options are salary and dividends, and the right mix depends on your specific situation.
Salary
When you pay yourself a salary, the corporation deducts it as an expense, which reduces the corporation's taxable income. You report the salary on your personal tax return and pay personal income tax on it.
Salary also means CPP contributions. As both the employer and employee, you pay both sides, which adds up. However, those contributions build your CPP retirement benefits and also create RRSP contribution room, which can be a significant tax planning tool.
Salary is a deductible expense for the corporation. That's an important distinction from dividends.
Dividends
Dividends are paid out of the corporation's after-tax income. The corporation doesn't get a deduction for paying them. However, dividends are taxed at a lower personal rate than salary because of the dividend tax credit.
Dividends do not create RRSP room and do not involve CPP contributions. For some people, that's a benefit (lower overall cost). For others, it's a missed opportunity to build retirement savings through RRSP contributions.
So which one is better?
Neither, in isolation. The right answer is almost always a combination of both, and the optimal mix depends on several factors that are specific to you.
Your personal income level: How much total income you have from all sources affects your marginal tax rate, which affects whether salary or dividends is more beneficial.
Your RRSP room. If you want to maximize RRSP contributions (which reduce your personal tax), you need salary to create that room. Dividends don't do this.
CPP considerations. Are you already maximizing CPP through other employment? If so, additional CPP through salary may not be beneficial.
Family situation. Dividends can be paid to family members who are shareholders (subject to tax on split income rules), which may create income splitting opportunities that salary doesn't.
Your age and retirement plans. The closer you are to retirement, the more these decisions compound in either direction.
The cost of getting it wrong
The difference between an optimized salary/dividend mix and a poorly structured one can be thousands of dollars in unnecessary tax. Many business owners default to one approach, all salary or all dividends, without ever running the numbers.
What to do
The right mix depends on your specific situation. A CPA can model different scenarios based on your income, family structure, RRSP room, and CPP position and recommend the approach that works best for you.
