Incorporation – Taxation of Salary and Dividends

In my last post, I discussed the lower tax rates on professional income earned in a corporation.

In BC, any professional income that you earn personally in excess of $132,000 is taxed at 43.7%.  In a professional corporation, the first $500,000 of that income is only taxed at 13.5%.  That’s a difference of over 30%.

Sounds pretty good to me. Lower tax rate means less tax. Less tax means more money. More money means….

If only it were that simple.

That money belongs to the company, not you. Somehow you have to get it out of your corporation so that you can use it.

You can’t just take the money. If you do, it will be included in your income as an appropriation and the company won’t get a deduction.  The company pays tax at 13.5% on the income earned, and then you pay tax at your regular personal tax rates on what you took out. You end up paying a lot more tax than if you had earned the income directly in the first place.

Doesn’t sound so good any more.

However, there are several tax effective ways to access money that is earned by a professional corporation; the two main methods are salary and dividends.

Salary / Wages

When you draw a salary, the company gets a deduction and pays no tax on the income earned to pay you. You will pay tax on the salary at your regular personal tax rates.

Dividends

If the professional corporation doesn’t pay you a salary, the net business income in the company is taxed at 13.5%.  The company can then pay dividends from what is left over after tax.

The personal tax rates on dividends are substantially lower than the rates on regular income. The lower rates compensate for the income tax already paid by the corporation.

BC Income Tax Rates

2012 BC Personal Tax Rates

As you can see in the above table, there are two types of dividends; eligible and non-eligible.

If you recall my previous post, I explained that the first $500,000 of active business income is taxed at 13.5% in BC.  Income in excess of $500,000 is taxed at 25%.

Basically, eligible dividends are paid out of income taxed at the higher rate, and non-eligible dividends are paid out of income taxed at the lower rate. There are other forms of income (i.e. investment) that are included in the different types of dividends, but that is for a future article.

Salary or Dividends?

Should you pay yourself with salary or dividends? If you need all of your income for personal use, there’s not a lot of difference.

The above table compares earning income directly to earning in a company and paying salary or dividends.  Please note that the analysis does not factor in accounting and legal fees which are going to be higher when you have a corporation.

The biggest advantage appears to be when you pay yourself with dividends only – but $4,600 of this advantage is because Canada Pension Plan (CPP) is not paid on dividends. However, when comparing between dividends and salary, there are a lot of other factors to consider (including the decision to contribute to CPP) which will be the topic of yet another post.

My intention is simply to show that the overall impact of earning income personally or in a professional corporation is essentially the same.

And if that’s the case, other than some advantages in paying for nondeductible expenses, why would someone choose to incorporate?

I’ll tell you in my next post.

John Moore, accountant for doctors, dentists, lawyers and other business professionals, Vancouver, British Columbia

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About John Moore

I am a Chartered Professional Accountant (CPA,CA) based in Vancouver, BC who helps doctors, dentists, lawyers and other business professionals keep more of what they earn. I provide tax, accounting and financial planning services for professionals and business owners.
This entry was posted in Architects, Business Professionals, Businesses, Chiropractors, Dentists, Doctors, Engineers, Health Professionals, Income Tax, Incorporation, Lawyers, Medical Residents, Mortgage Brokers, Optometrists, Professional Corporation, Realtors, Veterinarians and tagged , , . Bookmark the permalink.

3 Responses to Incorporation – Taxation of Salary and Dividends

  1. Mo Jangda says:

    Is there a difference between what can qualify as a dividend vs. salary or is it just how it’s reported on your return?

    • John Moore says:

      They get reported on your personal tax return through information slips.

      Salary will have source deductions taken off and remitted to Canada Revenue Agency, and will be reported on a T4 slip. Dividends are reported on a T5 slip.

      If it’s your company, you can determine the amount of dividends and/or salary to be paid to you – usually in consultation with your accountant :)

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