Should I Take Salary Or Dividends?

By Thomas Fellhauer
Categories: Blog, Tax

If you are self-employed or a professional or you own a business, you are probably already doing tax planning each year to minimize the tax you pay.

Let’s see what is the best thing to do in British Columbia, Canada.

Even though no changes were included in the February 11, 2014 Federal Budget or the February 18, 2014 B.C. Budget, the previous changes announced in the February 19, 2013 B.C. Budget and the March 21, 2013 Federal Budget change the way dividends and salaries are taxed in 2014.

If you have incorporated, you probably earn active business income in your corporation and pay the small business rate (the rate in B.C. is 13.5%). This is a very favourable rate and was designed to encourage small businesses.

The Budgets did not make any changes to this 13.5% corporate tax rate. But the Budgets did announce changes to increase the personal tax rates. So even though the corporate rate did not change, when you want to withdraw funds from your corporation, you will pay more tax.

Most business owners take cash out of their corporations either by way of salary/bonus, or by way of dividend. There are some exceptions (e.g. shareholder loans, capital dividends, returns of capital) but I will focus on just these two.

Comparing salary vs. dividend is somewhat complicated because a salary is a deduction from the corporation’s income and therefore there is no corporate tax; there is only personal tax.

On the other hand, dividends are paid out after corporate taxes are paid, so there are two levels of tax: first corporate tax is paid and then personal tax is a second level of tax.

In addition, the comparison changes depending on what tax bracket you are in. So a dividend may be taxed less than a salary for someone in a low tax bracket compared to someone in a high tax bracket.

So let’s just analyze what has happened as a result of the B.C. Budget and the Federal Budget for someone in the top tax bracket in B.C. for 2014 ($150,000 of income).

If you are in the highest tax bracket and you have an additional $100,000 of gross profits earned in your corporation, and you flow it all through to yourself, this is what the tax rates were in 2013:  

 

Salary

Dividends

Total tax

$43,700

$42,660

Amount left after tax

$56,300

$57,340

Effective tax rate

43.7%

42.66%

From this you can see that both rates were quite close and dividends were taxed slightly lower than salary.

Under the new rates for 2014:

 

Salary

Dividends

Total tax

$45,800

$46,360

Amount left after tax

$54,200

$53,640

Effective tax rate

45.8%

46.36%

From this you will see that that the rates for both salary and dividends have gone up in 2014. You will also note that dividend rates go up more than salary rates, so it will be slightly more expensive to take dividends than salary in 2014.

There are other matters that should also be taken into consideration such as income splitting with other family members in lower tax brackets, Canada Pension Plan, Registered Retirement Savings Plans and protection from corporate creditors.

Tom Fellhauer heads up the Tax Group at Pushor Mitchell LLP. You can contact Tom at (250)869-1165, or at fellhauer@pushormitchell.com