When you’re a salaried employee, your employer deducts a portion of your salary and pays it to you. When you’re self-employed or own your business, however, the money that comes in is considered an earned income and has to be reported on your tax return. The good news is that as a small business owner in Canada, you can choose between receiving dividends or paying yourself as an owner with a salary. It all depends on how much or little money is coming in each month and what kind of taxes apply to each payment type.
You’re taxed differently between salaries and dividends
The final difference between salaries and dividends is that you’re taxed differently. For example, if you receive a salary of $50,000 per year and pay taxes at your highest marginal rate (around 50%), then half of that income would be considered taxable.
But if you received a dividend of $100,000 in the same year as your salary, then only half of it would be considered taxable because dividends aren’t considered wages or salaries under Canadian taxation laws. They’re profits from business operations.
As long as an employee receives more than 50% of their total compensation from dividends (whether in cash or through stock options), they need to file an annual tax return with CRA every year; otherwise, they will face penalties for under-reporting their taxable income.
Dividends are taxable income and subject to federal, and provincial tax rates
Dividends are taxable income and subject to federal, provincial, and territorial income tax rates. For example, if you have a $100 dividend from your company’s second-quarter earnings, it will be taxed at your marginal rate (which could be as high as 50% in some provinces).
That means that if you’re earning $50k per year as an employee and receive one extra dollar of net profit each month on top of what was already being paid out by the company, then this additional amount would get taxed at 50%.
On the other hand, if you were an owner who received more than $30k in dividends from their business during the same period and they were not taxable, then they would only be taxed on half of their total amount because only half goes into their income bracket (or “tax bracket”).
Self-employed individuals have the same tax rates as salaried employees
The difference between a salary and a dividend is the tax treatment. Dividends are considered taxable income, whereas salaries are not. The tax rate for both types of income is the same: 15% for federal taxes and 5% for provincial taxes (with the two highest rates being eliminated).
The exception to this rule is Ontario corporate minimum tax rate which applies to some self-employed individuals who don’t qualify for basic personal exemption. If you earn only $40K from your business during one year but are paid more than that amount in dividends, you will owe additional provincial taxes on those dividends alone!
In Ontario, dividends are deductible in calculating the Ontario corporate minimum tax rate
In Ontario, dividends are deductible from net business income in calculating the Ontario corporate minimum tax rate. The rate is 0.5%. The rate is calculated on the corporation’s net income, and dividends are deductible from this amount.
Dividends are taxable to shareholders if they’re paid out of funds that aren’t available for use by their companies (for example, cash reserves). However, when you receive a dividend cheque, you can deduct it immediately against your income taxes, even though it will be taxed at higher rates later!
You can pay yourself with either dividends or a salary
You may be pondering: “how to pay myself from my business?” The tax implications are the same whether you choose a salary or dividends. The only difference is that salaries are taxed higher than dividends. In contrast, if you receive a dividend from your business, it’s not taxed as income (so long as it’s less than $200).
This means that if your business pays itself more in cash by way of dividends than it would be paying itself in salary, then the former option will be more beneficial for them in terms of taxes owed and net profits made on their side hustle.
The bottom line is that you can use either method to pay yourself as a business owner in Canada. If you’re confident about your skills with numbers and finance, then dividends make sense because they’re easier to track. However, consider a salary if you want more control over your finances. Either way, knowing how each method works is important before deciding and sticking with it.