Salary, Dividend, and What Each One Builds

Two ordinary routes carry money from an incorporated company to the person who owns it. One is a salary, which the corporation deducts as an expense and which the owner reports as employment income. The other is a dividend, which the corporation pays out of income it has already been taxed on and which the owner reports under a mechanism built for that purpose. Both are used every day in Canada, both are lawful, and each one creates something the other does not. An owner who intends to fund an insurance contract from personal dollars meets the question in the same year the first premium falls due.

This page sets out what each route is on both sides of the transaction, what each one builds, and what each one costs the company to administer. It names no preference. This site does not rank a salary against a dividend, it does not present a contract as a reason to take either, and the arithmetic that settles the mix for a particular owner is a calculation that owner's CPA performs every year on figures this page does not have.

What is a salary, from the corporation's side and the owner's?

A salary is remuneration for work performed. The corporation deducts it as an expense, which reduces the income the corporation reports for the year. The owner receives employment income on a T4 slip. The payment carries source deductions, the corporation remits those amounts to the Canada Revenue Agency on a schedule, and payroll contributions arise on both sides.

On the corporation's side, paying a salary means opening and maintaining a payroll account with the Canada Revenue Agency, calculating the amounts to withhold each pay period, remitting them on the frequency assigned to the company, and filing the year end slips and summary. The payroll deductions guide published by the Canada Revenue Agency sets out those obligations and the deadlines attached to them. Directors carry personal exposure for amounts withheld from an employee and never remitted, which is the part of the obligation owners most often discover late.

On the owner's side, the amount is employment income in the year it is received, taxed at the personal graduated rates applying in the owner's province. Tax is collected across the year through the withholding, so the deposit is smaller than the figure on the payroll register. The gross figure is the one other systems read when they need a number for the owner, and the deposit is the one the household spends. Your CPA sets the salary figure, and this practice does not.

What is a dividend, from the corporation's side and the owner's?

A dividend is a distribution to a shareholder out of income the corporation has already paid tax on. The corporation takes no deduction for it. The shareholder includes it under Income Tax Act s.82, grossed up to approximate the corporate income behind it, and then claims the dividend tax credit under s.121 against the tax on that amount.

On the corporation's side, the payment is declared by the directors, paid on a class of shares, and recorded in the minute book. No payroll account is required for it and nothing is withheld when it is paid. The corporate statute the company was incorporated under imposes its own solvency conditions before a dividend can be declared, and the share structure has to permit a payment to the person receiving it. An information slip reports the amount after the year closes.

On the owner's side, the gross up and credit mechanism under Income Tax Act s.82 and s.121 exists so that corporate income distributed to a shareholder carries roughly the tax it would have carried had the shareholder earned it directly. The gross up restates the payment at something close to the corporate income behind it, and the credit gives the shareholder recognition for corporate tax already paid. Two classes of dividend exist, and which one applies depends on the rate the corporation's income bore. Your CPA identifies the class. A dividend declared by a corporation is a separate thing from a policy dividend paid by an insurer, and this page concerns the corporate one throughout.

What does a salary build that a dividend does not?

A salary is earned income. Earned income is what generates registered retirement savings plan contribution room, it is the base the Canada Pension Plan or the Quebec Pension Plan measures an entitlement on, and it produces an employment record that a lender reads on a mortgage application and that a parental leave program reads on a claim.

Contribution room for a registered retirement savings plan is created by earned income in the preceding year, at a proportion the Income Tax Act sets and within an annual ceiling. Room that was never created cannot be created later by paying a larger salary in a future year, though room already created and unused does carry forward. An owner who has drawn dividends for a decade and then reads a notice of assessment will see that decade recorded in the carry forward figure.

The Canada Pension Plan and the Quebec Pension Plan work on the same input. Contributions are made on employment earnings up to a yearly ceiling, the corporation pays a share and the owner pays a share, and the eventual entitlement is calculated from the contribution record. The employment record has uses outside the tax system as well. A lender assessing a mortgage application reads a T4 slip and a payroll history, and a parental leave program calculates a benefit from earnings it recognises, though whether a controlling owner's employment is insurable at all is a question with rules of its own.

What does a dividend do that a salary does not?

A dividend moves money to a shareholder without payroll machinery. Nothing is withheld at source, no remittance schedule applies to it, and no contribution to the Canada Pension Plan or the Quebec Pension Plan arises on it. It creates no earned income, so it generates no registered retirement savings plan room and no employment record.

The administrative consequence is real. A corporation that distributes only by dividend may have no payroll account to maintain, no remittance deadline to meet, and no year end payroll filing to prepare. The declaration is a corporate act recorded in the minutes, the timing sits with the directors inside the corporate year, and an information slip reports the amount for the shareholder's personal return. For a small company with one shareholder and no other employees, that is a lighter monthly obligation.

The same facts have a second face. Because nothing was withheld, the tax is settled personally, and the Canada Revenue Agency can require instalments from an owner whose personal tax is no longer collected at source. Because no contribution was made, no entitlement accrues under either pension plan for that year. And because no T4 slip exists, the file a lender reads is built from corporate statements and personal returns. None of that makes a dividend deficient. Those are consequences of the mechanism, and they belong in the annual calculation with everything else.

What does each one cost the corporation to administer?

A salary carries a payroll account, a remittance schedule, year end slips, and personal exposure for directors where amounts withheld are not remitted. A dividend carries a directors' resolution, a share structure that permits the payment, a solvency test under the corporate statute, and an information slip. One obligation runs monthly and one runs annually.

On the payroll side the cost is recurring. The company registers a payroll account, calculates the deductions each pay period, remits on the frequency the Canada Revenue Agency assigns, and files the slips and summary after the year closes. Late remittance attracts penalties and interest of its own. The payroll deductions guide sets out the obligations, and a bookkeeper or the company's accountant usually carries them, at a monthly cost the company can quote before the first pay period.

On the dividend side the cost is concentrated. The corporate statute sets conditions to be satisfied before a dividend is declared, the resolution and the minute book entry have to be prepared, the share structure has to support a payment to the person receiving it, and the information slip has to be filed. The paperwork is thinner across the year and the planning around it is not. Either way the professional fee is small measured against the tax consequence of a mix set without advice.

Why does the mechanism matter when the premium is paid personally?

A premium paid personally comes out of after tax personal income whichever route delivered the money. The mechanism matters anyway, because a salary creates registered room and a pension contribution record on the way through, and a dividend delivers the same personal dollars without either. An owner committing to a long premium schedule should know which one funds it.

A personally owned contract produces no deduction for anyone. The premium is a personal expense, paid from money that has already met the personal tax system, and the size of the commitment has to be measured against what lands in the personal account. The gross salary and the declared dividend are both larger figures than the amount available to pay a premium, and an owner who plans from the larger figure will meet the gap in a year the company has a poor one.

The sequence that works is short. The CPA sets the compensation figure for the year, the owner learns the after tax personal amount an ordinary year produces, and only then does a premium schedule get designed against it. The premium should come from surplus that exists in an ordinary year, which is the point made at length for professional corporations on incorporated physicians and retained earnings. A schedule built on a good year is a schedule the owner renegotiates later.

Is a corporately owned contract a compensation question?

No. Where the corporation applies for the contract, owns it and pays the premium, no money has moved to the owner personally, so no salary and no dividend has been declared. Corporate ownership raises its own questions about who owns, who pays and who is named, and those belong to the ownership decision on a separate page.

The two questions sit in different files. A compensation decision moves money from the corporation to the person, and its consequences are employment income, registered room, pension contributions and personal tax. An ownership decision settles whose name goes in the policyholder box, and its consequences are the corporate balance sheet, the capital dividend account at a death, and the risk of a benefit conferred on a shareholder. Answering one has never answered the other.

An owner sometimes hears a contract offered as a reason to take one form of compensation. That argument does not survive contact with the facts. A corporately owned contract is funded by the corporation and touches the compensation question only through the surplus it consumes. A personally owned contract is funded from after tax personal dollars that arrived by whichever route the accountant set. This site uses no contract as a reason to take salary and none as a reason to take dividends.

What does reasonableness require of a salary paid to a family member?

A salary paid to a spouse, a child or a parent is deductible to the corporation only where the amount is reasonable for work actually performed. Income Tax Act s.67 limits a deduction to what is reasonable in the circumstances, and the Canada Revenue Agency can deny the deduction where the pay and the work do not correspond.

Reasonable is judged on the work. The questions an auditor asks are what duties the family member performs, how many hours the role takes, what an unrelated person would be paid for the same duties, and whether any record of the work exists. A job description, a record of hours and a payroll register answer all four. The assessment arrives years later, covering several years at once, and the file assembled at the time is the only evidence available by then.

The dividend side carries its own family rules. The tax on split income rules in the Income Tax Act can apply to dividends paid to family members who are insufficiently involved in the business, and where they apply the recipient is taxed at the highest personal rate on the amount. Which family members sit outside those rules depends on age, hours worked, share ownership and the nature of the business. That determination belongs to the owner's CPA on the actual facts, and it is reviewed when the family or the business changes.

Does this page recommend one of the two?

No. This site does not rank a salary against a dividend and it names no preferred mix. Both routes are ordinary, both are used across Canada, and the figures that settle the question for one owner have no bearing on the next. Nothing on this page is tax advice or a recommendation about how an owner should be paid.

The inputs are personal and they move. The corporation's income and the rate it bore, the owner's other income, the province of residence, the household's cash requirement, the registered room already carried forward, the owner's age and the years left before a pension is drawn, and the presence of a spouse or an adult child in the business all enter the calculation. Change any one of them and the answer can change with it.

Underneath both routes sits the design of the Canadian system. Corporate income distributed to a shareholder is intended to bear approximately the tax it would have borne had the shareholder earned it directly, which is what the gross up under Income Tax Act s.82 and the credit under s.121 are built to accomplish. The approximation is close and it is imperfect, and the size of the imperfection depends on the province and on the type of corporate income. Your CPA measures it on your own file.

Who runs the calculation, and how often?

The owner's CPA runs it, on the owner's own file, at least once a year. The inputs move with the corporation's income, the owner's other income, the province, the family and the registered room already carried forward. A mix that suited one year can suit the next poorly, which is why the question returns at every year end.

The exercise is short when the papers are ready. The CPA needs the corporation's projected income and the type of income it is, the owner's personal cash requirement, the most recent notice of assessment showing carried forward registered room, any premium the owner has already committed to, and any shareholders agreement constraining what can be paid on the shares. Owners who bring those five items get an answer in one meeting.

Timing belongs to the same conversation. A salary decided before the corporate year end can be accrued and deducted for that year, provided it is paid within the period the Income Tax Act allows, and a CPA tracks that date. A dividend can be declared later, and the year in which it is received governs the shareholder's personal return. Decisions taken after the year has closed have fewer choices left in them, so the meeting belongs before the year end.

What belongs in writing before the year end?

Four short answers. The salary figure and the work it pays for. The dividend figure and the class of shares it is paid on. Confirmation that any amount paid to a family member is reasonable for the work performed. And the after tax personal amount the owner can commit to a premium in an ordinary year.

Writing it down costs an hour and it settles years. The professional who gave a verbal answer may not be in the file when the question is asked again, an auditor reads records and never intentions, and the note kept with the corporate minutes explains a decision to whoever reads it next. Owners who keep that note find the following year's meeting shorter, because the starting point is already on paper. The wider framework an incorporated owner works inside is set out across the business owners section.

An advisor's contribution here is narrow and worth stating. This practice holds an insurance licence, gives no tax advice and no legal advice, and takes no position on how an owner should be paid. A Financial Security Advisor can say what a proposed premium schedule requires in after tax personal dollars each year, can say what happens to the contract if that amount stops arriving, and can wait for the accountant's figure before designing anything.

Who this suits, and who it does not

This page suits an incorporated owner who draws money from the company and has never seen the two mechanisms set out plainly on both sides. It suits an owner considering a premium funded from personal dollars who wants to know what the funding route builds along the way. It applies with most force where a long schedule is contemplated and where the household has other plans the compensation figure feeds.

It applies with less force to an owner whose compensation is already fixed by a partnership agreement, by a professional body's rules, or by an employer who issues the slip. It applies with less force again where the corporation has no durable surplus to distribute in a normal year, because the mix question sits downstream of whether there is anything to distribute. Those owners can settle the surplus question first and return to this page afterwards.

It does not suit a reader who came for a rule. No rule exists here, and this page declines to supply one. Participating whole life insurance is an insurance contract and it is not an investment, and the compensation mix that fits one owner is decided on facts this page does not hold: the corporation's income, the owner's province, the household's requirement, the family, and what the owner's CPA concludes when the figures are in front of them.

Answer the two questions underneath the mix before answering the mix itself. What does the household need in after tax dollars each month, and what can the corporation pay in an ordinary year without borrowing to do it. An owner who can answer both can evaluate any compensation figure an accountant proposes, and an owner who cannot will take whichever figure the previous year defaulted to.