All the leaves are brown. (Thinking of a Salary or a Dividend?)

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The leaves are brown but the sky is definitely not gray.  What a gorgeous September.  The month of July, August and September have been eventful for the firm.  Both partners enjoyed some relaxing vacation  time in Calgary and abroad. With the last three months of the year upon us the office is busy.  We have all hands on deck and look forward to tackling another busy season. Of course, we’ll also be taking some time to enjoy Calgary’s beautiful fall weather.  This week, we would like to discuss a significant accounting and tax issue we often encounter with both start up and established businesses: how to compensate the business owner. Once a business is incorporated, it is established as a legal entity know as a corporation.  The corporation is now a separate entity from the business owner.  As a result, business owners cannot simply withdraw cash from the company without tax consequences.  Corporations will need a formalized structures in place to pay the business owner. This structure is important because it will have cash management and tax implications. The two most common methods of remuneration are salary or dividend.The following considerations should be examined when putting formalized payment structures into place.  We strongly advise discussing  the following with a qualified accountant to determine what option best suits your business model. v  Salaries are considered to be active income.  Dividends are investment income.  RRSP contribution room is calculated on active income.  With active income (salary) the taxpayer’s RRSP room increases.  If your only source of income is dividends, the taxpayer cannot build RRSP room nor benefit from certain tax deductions, such as child care expenses.v  Salaries are considered operating expenses for the corporation.  They are fully deductible in the corporation.  The salaries are then taxed normally through the personal tax payer.  Dividends are not an expense for the corporation.  The dividends are taxed as investment income through the personal tax payer.   There is a tax credit available on the dividends.v   Salaries require additional administration.  Each month deductions have to be calculated and remitted to the CRA. v  With a salary, taxes are deducted from each pay cheque. As dividends are usually lump sum withdraws, the taxpayer must pay the applicable taxes when they file their personal tax return.v  CPP is not payable on dividends.v  Depending on the corporate structure, dividends can be strategically claimed to defer personal taxes and declare income to different shareholders. v  Salaries must be paid to employees of the company and dividends paid to shareholders.  If you are not an employee or not a shareholder, the choice has already been made.
As you can see, there are tax consequences and other factors to consider when determining remuneration from your company.  The decision all depends on specific circumstances for each business and owner.