Demystifying the pros and cons of business owner compensation in Canada

When it comes to compensating business owners in Canada, two primary options stand out: payroll and dividends. Both methods come with their own unique benefits and drawbacks, making it crucial for entrepreneurs to understand the differences between the two. Finngo Bookkeeping & Tax is here to help you navigate this complex topic, ensuring you make the best decision for your business.

1. Payroll – A Steady Income Stream

Payroll is a conventional method of compensating business owners for their work in the company. By setting up a regular salary, business owners can enjoy a consistent income, allowing them to plan their personal finances more effectively.

Pros:

• Regular income: Payroll provides business owners with a predictable salary, simplifying budgeting and financial planning.
• Canada Pension Plan (CPP) contributions: Payroll allows business owners to contribute to their CPP, increasing their retirement benefits.
• Tax deductions: Salaries are considered a business expense, providing tax deductions for the company.
• RRSP contribution room: Payroll income increases the available Registered Retirement Savings Plan (RRSP) contribution room, allowing for tax-deferred savings.

Cons:

• Higher tax rates: Salaries are subject to personal income tax, which can result in higher tax rates compared to dividends.
• Payroll taxes: Employers are required to contribute to the CPP and Employment Insurance (EI) for employees, including the business owner, resulting in additional costs.

2. Dividends – Profit-Based Compensation

Dividends are payments made to shareholders from a company’s after-tax profits.

For business owners, this compensation method can provide a more tax-efficient way to access company earnings.

Pros:

• Tax advantages: Dividends are taxed at a lower rate than salaries, potentially saving business owners money on their personal taxes.
• Flexibility: Dividends offer more flexibility in terms of payment frequency and amounts, allowing business owners to adjust their compensation based on the company’s financial performance.
• No CPP or EI contributions: Dividends are not subject to CPP or EI contributions, reducing the overall cost to the company.

Cons:

• No CPP contributions: Since dividends do not contribute to the CPP, business owners may receive lower retirement benefits.
• No RRSP contribution room: Dividends do not increase the available RRSP contribution room, potentially limiting tax-deferred savings opportunities.
• Limited tax deductions: Dividends are not considered a business expense, so they do not provide the company with tax deductions.

Choosing between payroll and dividends for business owner compensation in Canada ultimately depends on the individual’s financial goals and the company’s circumstances. Each method has its advantages and disadvantages, making it essential to consult with a professional to make the best decision. Finngo Bookkeeping & Tax is here to help you explore your options and create a tailored compensation strategy that meets your needs. Contact us today to schedule a consultation and start optimizing your business owner compensation.