I know, I know. The last thing you want to hear about is taxes. After all, the tax season just wrapped up and you’ve paid all your taxes, so why am I still talking about them? It’s because I often get asked by doctors and lawyers whether it’s better to pay themselves by salary or by dividends from their corporation.
In today’s post, we’ll take a look at the salary vs. dividend question for your professional corporation.
In my last blog post, I discussed why as a professional, you should consider incorporating your practice. Once you decided to incorporate, you then need to figure out whether you should pay yourself through salary or dividends, but it’s not a simple decision.
Now remember, your primary goal in setting up a corporation is to save money inside the corporation. Whatever you leave in your corporation to invest has only paid that first step of tax, i.e. the corporate tax, such that there’s more to invest. What we’re talking about here is the money you have to take out of your corporation to live on each year.
There is a fundamental concept in taxation that you need to understand. It is known as Tax Integration. As I explained in my last episode, the way our tax system is set up, if you earn money in your corporation and then channel that money into your personal name within the same year, the total amount of tax you pay should be about the same as if you got paid a salary directly by your employer without a company in between. The tax integration concept says that this should be true, whether you choose to pay yourself by dividend or by salary.
Now tax integration sounds nice and the federal and provincial governments try to make sure it is always the case, but in practice, it is not perfect. There are small differences in overall tax rates that occur when you pay yourself through your corporation by salary or dividends. It turns out that under the current tax rates in most provinces, there is actually a slight advantage to paying yourself through salary. About 0.9% in Quebec, when your company makes less than $500K. When your company is earning more than $500K, that advantage grows to 2.7% in Quebec.
That being said, there are other reasons to pay yourself by salary instead of dividends. You will be contributing towards your QPP or CPP. In Quebec, you’ll also be contributing to the Quebec Parental Insurance Plan, which may come into the decision if you plan on having children, and taking time off work when you do. It will allow you to claim childcare expenses, for which you need to have an “earned” income to deduct those expenses against. Taking a salary also creates RRSP contribution room, which is deductible from your personal income and allows you to save and invest in a tax sheltered account. Finally, having salary income will help you with a mortgage application, if you intend to buy a house. The banks don’t consider dividend income as stable when looking at how much of a mortgage you can afford.
So what’s the bottom line?
Once you’ve set aside as much savings as possible inside your corporation, I recommend drawing salary to fund your lifestyle needs. This will maximize your QPP or CPP contributions and your RRSP contribution room, along with some of the other benefits mentioned. This recommendation may change in years to come, since tax rates are constantly changing, but for 2017, salary is the clear winner. As I mentioned in my previous video: The federal government announced in their last budget that they are going to review these rules, to reduce the benefit of incorporation. If you’re not incorporated yet or are on the fence about it, it may be worth waiting until the fall budget update before spending the money to do so.