Blogs & Comment

Dividends or salary if incorporated?

When you incorporate, you can choose to receive income in the form of salary or dividends. Whats the right mix?
Some business owners may want only dividends because they are generally taxed at a lower rate. But dividend income cannot be put into an RRSP, whereas salary can. And if you crunch the numbers, youll see that the RRSP factor tilts the decision toward salary income if the businessperson is still in the accumulation stage of the investing life-cycle. So says Ross McShane, a McLarty & Co. financial adviser and Ottawa Citizen blogger.
To see this, lets say the business owner elects to pay themselves a salary of $122,222 in order to make the maximum contribution of $22,000 to their RRSP in 2010. This would provide roughly $68,700 in after tax dollars after contributing to the RRSP and claiming the tax deduction, calculates McShane.
The same amount of after-tax income would be obtained if $76,500 of ineligible dividends were paid by the corporation. After corporate taxes, that would leave $25,555 to invest within the corporation.
So, salary income leaves $22,000 to invest in an RRSP while dividend income leaves $3,555 more ($25,555-$22,000) to invest inside the corporation. However, investment income earned within the RRSP grows tax free whereas investment income earned within the corporation is passive income and subject to the highest marginal tax rate. Unless all corporate investment income is in the form of unrealized capital gains, the salary-RRSP approach appears to be better during the accumulation phase of ones life cycle.
To be continued in next post.