Many clients with their own pharmacy business, or incorporated reliefs pharmacists, want to know whether a salary or dividend would be better for them financially. Because each individual’s case is different, the answer to this will depend on their unique circumstances, as there are some pros and cons to both methods of payment.
Benefits of Salary
Choosing to receive a salary instead of dividends offers certain advantages. Firstly, opting for wages allows you to accumulate RRSP contribution room, unlike dividends, allowing you to invest in your RRSP for future financial growth.
Secondly, wages enable contributions to the Canada Pension Plan, which can prove beneficial in the long term, especially if you find it difficult to save to prepare for retirement yourself. However, CPP payments are a current cost to both you and your business.
Additionally, wages have tax automatically withheld, reducing the likelihood of unexpected tax bills during filing. This differs from dividends, which often result in tax liabilities that may not be adequately planned for.
Moreover, when it comes to mortgage qualification, banks typically prefer steady income, making wages a more favourable option to them, compared to dividend income. This can make it easier to get a loan approval if you’re planning a home purchase in the near future.
Furthermore, certain government subsidies and tax credits, such as the Canadian Emergency Wage Subsidy and the Canada Workers Benefit, require a wage income, so a salary may be a benefit to you in specific situations. This includes benefits such as the Canadian Emergency Wage Subsidy program.
It’s also worth noting that paying a salary is considered earned income, which is necessary to claim expenses like childcare, donations, and more.
Receiving a salary is classified as earned income, which you need for claiming expenses such as childcare, donations, and medical expenses on your personal tax return. Moreover, it allows you to use your business for managing medical expenses through a health spending account or group benefit plan, as you are recognized as an employee.
Considerations for Salary
Receiving a salary results in lower taxes initially, but becomes more costly compared to dividends when considering CPP contributions. However, if you can leverage tax deductions for expenses like childcare, donations, and medical expenses, the additional expense of CPP may be justified.
Benefits of Dividends
Opting for dividends simplifies business operations. If you own your corporation, you can easily declare dividends and transfer funds to your personal account without dealing with payroll complexities. With this, annual T5 filings are sufficient.
Dividends also mitigate late filing penalties. You avoid the hassle of monthly payroll payments, the risk of missing payroll deadlines, and their associated fines. Timely T5 filings are essential; if timely payroll payments start to be a challenge, dividends offer a simpler alternative.
Incorporating helps defer personal taxes, as most taxes are paid at that level. Owners can manage their tax payments by setting compensation based on living costs. Any extra cash in the corporation is taxed at the lower corporate rate
Dividends result in lower employer health taxes in certain Canadian provinces, as these taxes usually apply to wages, not dividends.
You can invest the money saved on CPP contributions over time to create your own pension; this can be especially beneficial if you don’t tend to leverage RRSP contributions or need to claim expenses like childcare or medical expenses.
Considerations for Dividends
Dividends can pose challenges for some people who may tend to overspend, not putting enough aside for tax season, because dividends do not have automatic tax deductions. Additionally, dividends don’t let you contribute to CPP, so it’s crucial to plan for retirement accordingly, and be more proactive in saving for retirement.
Dividends are also distributed based on share ownership, so it can be difficult to allocate income amongst shareholders with the same class of shares.
Tax Integration
The purpose of tax integration is to equalize the overall tax burden between salary and dividends by better balancing corporate and personal taxes.
As a result of tax integration, both dividends and salaries are taxed almost the same when you consider both the corporate and personal taxes you pay.
Essentially, salary results in lower corporate taxes because it is a tax deduction to the corporation. Therefore, no corporate tax is paid on salary and shifts the entire tax burden to the personal side.
Dividends are not tax deductions to the corporation, therefore you must pay corporate tax first before you can pay any dividends. Since your corporation has paid some taxes already, less of tha tax burden is shifted to the personal side and you pay less personal tax.
With integration, the rules are aimed at ensuring that the total taxes paid, including both corporate and personal taxes, are equivalent regardless of whether salary or dividends are utilized.
Income Splitting
Legislative changes since 2018 have made it difficult to split income with family members using dividends.
Previously, a strategy of dividend sprinkling was possible, which allowed shareholders to pay dividends to lower-income family members who did not work in the business. Since the family members were in lower tax brackets, the overall family tax burden was lower.
However, the Tax on Split Income (TOSI) rules put an end to this for most businesses. While not impossible, certain rules need to be followed.
Splitting income is much easier when it comes to salary, however the family member must be working for the business.
Conclusion
Every individual’s circumstances are different. As part of analyzing your situation, it’s essential to factor in both business and personal tax paid, not just personal tax, to get the full, accurate picture.
Paying yourself salary or dividends, or a combination of both requires an analysis of what tax deductions & credits you are eligible for, the amounts, and how it all affects your overall tax burden. Both the amount of corporate tax and personal tax you pay needs to be considered.
In complex tax situations like these, to determine whether salaries or dividends are more tax efficient, specialized expertise can make all the difference.
Pharma Tax knows each case is different, and the answer will vary depending on each individual. We specialize in helping pharmacists and pharmacy owners minimize their tax burden, helping them grow their wealth better, and providing peace of mind.
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