Should I Take Salary or Dividends?

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 $100,000 of gross profits are earned in a corporation, and you flow it all through to the shareholder, this is the total of both levels of tax under the current rates for 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 are quite close and dividends are 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 will go up in 2014.  You will also note that dividend rates go up more than salary rates, so in 2014, it will be slightly more expensive to take dividends than salary.