Wages Vs. Dividends Income For Business Owners

Kelowna AccountantKelowna accountant, Ken Davidson, answers your questions on accounting, business growth strategies, start-ups and more.

Question from a Reader: As a business owner should I take a wage or dividends?

As far as I’m concerned, there are very few reasons why a business owner should take a wage. When I say this I’m referring specifically to business owners that have incorporated their business, because it’s a whole different situation if you’re a sole- proprietor.

All of my clients earn dividends rather than wages but the question is why? There are a couple reasons why this is works to your benefit.

CPP (Canadian Pension Plan)

I believe the CPP is a tax rather than a savings vehicle.  I recommend that my clients look after their own retirement rather than depending on CPP. Costs will escalate over the next few years and as a business owner, you’re paying both sides of the CPP, the employer and employee contribution.

You’re competing against people (employees) who are earning wages and receiving a 100% return on the money they put into the CPP pool because it’s matched by their employer. This means as a business owner, you’re putting in your $100 and you match it with your own $100 so your rate of return is zero. If an employee puts in $100, the business will put in $100 to match and they have already got 100% return on their money the minute they start.

In a nutshell, the CPP is great for employees but terrible for business owners.

By going to a dividend model, you avoid CPP altogether, making it a true savings and quite often the best choice for business owners. By not paying into the CPP, you could be saving yourself over $4,000 a year. Not bad!

Related: Taking A Risk In Business: What Your Accountant Won’t Tell You

Kelowna AccountantIncome Splitting With A Spouse (aka Dividend Sprinkling)

If you’re pulling a wage for your significant other, it needs to be reasonable for the service or work performed.  Dividends are not subject to this same reasonableness test.

I touched on this specific situation in my recent blog, Can I Pay My Spouse That Doesn’t Work In My Business? It’s a good resource to check for more info on dividend sprinkling but make sure you speak with your Kelowna accountant before making any final decisions.

There Are Always Exceptions

Although dividends are generally the best way to go, there are certain circumstances where pulling a wage is the better route. These are less common but this is why it’s always best to consult your Kelowna accountant when making these decisions. You want to make the right call, the first time!

Related: 5 Tax Tips That Challenge The Status Quo

What About RRSPs?

If you are someone who believes in RRSPs than you have to pay wages to yourself in order to generate contribution room. I generally don’t think that RRSPs are the right decision for business owners. I believe there are other ways of saving (using pre-tax dollars) that are more beneficial to an entrepreneur.

The main thing to keep in mind is that if you plan to flow all of the funds out of your corporation on an annual basis to yourself, the only two advantages are income splitting and CPP.

There are very few reasons to collect wages as a business owner and it’s crucial that you speak with your Kelowna accountant to determine if it makes sense for you personally. More often than not, the best way is dividends.

 

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