Paying yourself – taxation on salary vs dividends

You’re the sole owner of a small business. Your business yielded a profit this year. If you pay yourself a salary1, the company will pay no taxes (salaries are deductible as company expense), and the the money paid to you will be taxed according to your personal tax bracket. If you pay yourself dividends, the corporation will be taxed; then, the dividends paid to you will be taxed. Canadian dividends are taxed at a reduced rate, since the company was already taxed on the earnings.

So which method of payment will leave more money in your pocket?

The Canadian income tax system is based on the “theory of integration”. The theory is that there should be no difference between earning income personally, or earning it in a corporation and then paying that income out to yourself as dividends. If integration is perfect, the amount of income in your hands would be exactly the same, either way.

However, integration depends on a synergy of tax rates, and perfect integration doesn’t aways occur.

So in the spirit of do-it-yourself tax planning, lets check the numbers!
I took the 2016 tax rates from TaxTips.ca, but you can plug in the applicable rates to your year and location.
The calculations assume you earned the money this year, e.g., you haven’t already paid corporate tax on the money in previous years, and they ignore CPP deductions.

% BC Combined Federal+Provincial tax rate for a CCPC (Canadian Controlled Private Corporation) in 2016

Income bracket

% BC Combined Federal+Provincial personal income marginal tax rate

% BC Combined Federal+Provincial marginal tax rate on non-eligible Canadian dividends

% Overall tax rate if corporation owner is paid by dividends

% Difference between salary and dividends tax rates

Conclusion:2 For BC in 2016, the theory of integration seems to be working! The difference in the overall taxes between paying yourself by salary or by dividends is less than 2/3%, with a small advantage to the salary method. Consider that sheltering some of the salary in an RRSP could reduce the taxes paid even further.

1 You can get paid either as a company employee, filing a T4, or possibly as a contractor of your own company, filing a T4A, which is much less paper work.
2 I’m not an accountant. Your feedback is welcomed.

Further reading:

Salary or Dividends – How Do I Pay Myself?

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