Should I Take Salary Or Dividends?

If you operate your own business through a corporation in BC, 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 right now.

Even though no changes were included in the 2023 Federal Budget or the 2023 B.C. Budget, the tax brackets are increased each year to reflect (somewhat) the increases to the cost of living.

If you have incorporated, you probably earn active business income in your corporation and pay corporate tax at 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 for the higher tax brackets..  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.

Let’s just analyze what the current situation is in BC in 2023 for someone in the top tax bracket in B.C. (over $240,716 of income).

If $200,000 of gross profits are earned in a corporation, and you flow it all through to the shareholder, there are two different calculations: salary or dividend.

For these illustrations, assume that this $200,000 would be entirely over the $240,716 threshold for the top tax rate.  For simplicity, I will ignore the potential application of the alternative minimum tax (AMT) and I will disregard CPP and EI premiums and Federal and Provincial tax credits on the salary as those would be maximized before reaching the top tax rate.

Salary of $200,000

Since a salary is deductible for the corporation, there is no corporate tax on the $200,000 paid as a salary (unless it is “unreasonable”).  But the salary is added to the shareholder’s income.

The $200,000 salary would be taxed at the top BC rate of 53.5%.  This would result in income tax of $107,000. The net after-tax on the $200,000 salary would be $93,000 ($200,000 - $107,000)!

Payment of a salary would raise the maximum available for an RRSP contribution which is some benefit.

Dividend of $200,000

A dividend is not deductible for the corporation. So first, we have to account for corporate tax.  The corporate tax rate in BC for an active business (up to $500,000 per year) is 11%.  In other words, to pay a dividend of $200,000 to the shareholder, the company has to have income of $224,719.  After paying the 11% corporate tax, the corporation would be left with $200,000 to pay out a dividend.

The tax on dividends received by the shareholder depends on whether or not the corporation has paid the high rate of corporate tax or the low rate.  Assuming that the corporation’s income is earned from carrying on an active business and not from earning dividends from investment income, this would be taxed at the low rate so this dividend would be classified as an “other than eligible” dividend.

This kind of dividend would be taxed at 48.89%.  The tax on the $200,000 dividend would be $97,780.

Too try to match the salary illustration, we should factor in the corporate tax paid as well.  The total corporate and personal tax would be $122,499 ($24,719 + $97,780).

There is a tax disadvantage for dividends in this illustration. The total tax with the dividend would be $122,499 vs. $107,000 for salary.

The concept of “tax integration” was to try to ensure that salaries and dividends are roughly equal.  You can see from these illustrations that under these facts, a salary has a distinct tax advantage vs. dividends.

There are many, many other possible illustrations with different salaries and lower total income that come out with a different result.  But this is a general illustration about how a salary vs. dividend comparison is done.  Best to discuss your own personal situation with a tax accountant who can use your own actual dollar amounts.

There was a time when dividends resulted in less tax than salaries, but as a result of changes in the tax rates, the opposite occurs.

In an ideal world, tax integration would ensure that there is little or no difference as to whether a shareholder chooses to receive a salary or a dividend.  It appears that the Federal Government wishes to favour salaries.

Thomas Fellhauer, Partner, Pushor Mitchell LLP.

 

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