When it comes to owner-managed incorporated businesses in Manitoba, one of the key decisions to make is how to pay oneself - through a salary or dividends. This decision has implications for tax, cash flow, retirement planning, Canada Pension Plan (CPP) contributions, and workplace injury coverage.
Salary vs Dividends: An Overview
A salary is a fixed regular payment made by an employer to an employee. It counts as personal income and impacts your RRSP (Registered Retirement Savings Plan) deduction room1. Dividends, however, are considered investment income, paid out of the corporation's after-tax retained earnings. They may yield a marginally lower tax rate than what is usually paid on a salary.
Salary Tax Implications
For a salary of $100,000 in Manitoba, the total tax paid would be approximately $34,118, leaving a net pay of $65,8822. This is based on the provincial tax rates of 10.8% for the first $47,000 and 17.4% for the amount over $79,625 for the year 2024. Additionally, salary income is subject to Canada Pension Plan (CPP) contributions, which would further reduce the take-home pay but also provide CPP benefits in the future.
Dividend Tax Implications
Dividends are taxed differently. They are subject to a gross-up and dividend tax credit system. In 2023, the gross-up rate for eligible dividends is 38%, and for non-eligible dividends, it is 15%. This means that for tax purposes, $100,000 in eligible dividends would be grossed up to $138,000. The actual tax payable would depend on the individual's marginal tax rate and the dividend tax credit they are eligible to claim. The dividend tax credit is designed to account for the corporate tax that has already been paid, thus avoiding double taxation.
Comparative Analysis
When comparing the two, it's important to note that while dividends may be taxed at a lower rate personally, they do not allow for CPP contributions or generate RRSP room, which can be significant for retirement planning. On the other hand, a salary would be taxed at a higher rate but is a deductible expense for the corporation, which could lower the corporation's taxable income.
CPP Contributions
Salary income is considered pensionable earnings for CPP/QPP purposes, while dividend income is not. Therefore, if you receive salary income, you may be entitled to CPP/QPP benefits, which may include a retirement pension and survivor, death, and disability benefits available to CPP/QPP contributors and their family members1. Paying yourself a salary means you will also be paying into the CPP, which can be an important retirement consideration.
Cash Flow
Dividends can be more flexible and economical from a cash flow perspective. There's no need to make payroll remittances from the corporation, and a dividend can be paid out anytime. This flexibility can be particularly beneficial for small businesses that need to manage their cash flow carefully.
Retirement Planning
Only a salary generates RRSP room2. This means that if you're planning for retirement, paying yourself a salary could be more beneficial as it allows you to contribute to your RRSP and reduce your taxable income6. Additionally, an owner-manager who receives pension-eligible income may be a candidate for an Individual Pension Plan (IPP).
Workplace Injury Coverage
As a business owner actively working in the business, you are not automatically covered for your own workplace injuries or illnesses unless you choose to purchase Personal Coverage from the Workers Compensation Board of Manitoba (WCB). This coverage provides benefits similar to those available to workers, including income replacement and medical costs.
Other Considerations
If you're planning to apply for a home mortgage or loan, paying yourself a steady salary is the way to go.. Dividends might be a better option if you want to keep your payroll costs low and maintain flexibility in your cash flow.
Conclusion
In Manitoba, the decision between taking a salary or dividends from an owner-managed business should be based on a combination of immediate tax implications, cash flow considerations, retirement planning, and CPP contributions. The choice will vary depending on the business owner's personal circumstances, future plans, and the current financial health of the business. It is advisable for business owners to consult us to make the most informed decision for their specific situation.