SALARY OR DIVIDEND, WHAT’S YOUR CHOICE?
When an entrepreneur chooses to set up a joint-stock company (société par actions or SPA), this means that as a shareholder, he or she can decide on the form in which he or she will be remunerated. Is it better for him to receive a dividend or a salary? To what extent do the tax changes planned by the new government modulate the answer to this question?
To determine the best form of remuneration, we need to know how much money (after tax) the shareholder needs to maintain his lifestyle. The best scenario will be the one that reduces the after-tax cash outflow for the SPA.
When a salary is paid, the SPA must pay social charges, i.e. the employer’s portion for the Régie des rentes du Québec (RRQ), the Régime québécois d’assurance parentale, the contribution to the Fonds des services de santé, and so on.
The salary and social charges are deductible for the SPA, and the salary will be taxable in the hands of the shareholder.
The dividend is not a deductible expense in the SPA. The shareholder will be taxed on this amount, taking into account gross-ups and dividend credits. In addition, he will have to pay the Health Services Fund.
In principle, the Canadian tax system provides for integration, meaning that the taxes collected when income is earned by a corporation and distributed as a dividend to its shareholders must be equivalent to those that would be collected if the income were earned directly by an individual. Since these integration principles are established using the highest marginal tax rate applicable to individuals, integration is not perfect when the shareholder is not already taxed at the highest marginal rate.
Increase for 2013
For example, an individual who needs $80,000 a year after taxes will receive, in 2012, a salary of $127,250 or a dividend of $100,500.
For SPA, the net after-tax cost of the salary payment will be $108,200, compared with $100,500 for the dividend. It is therefore more advantageous for the SPA to pay a dividend. Calculations are based on the assumption that the company has a tax rate of 19%, i.e. taxable income of less than $500,000.
For 2013, salaries and dividends will have to be increased to $128,500 and $101,400 respectively, to reflect the increase in the tax rate on income exceeding $100,000. The net after-tax cost to the SPA will be $109,200 for the salary or $101,400 for the dividend. The SPA does not have to adjust the salary or dividend to help the shareholder pay the health contribution because, at this income level, the health contribution will be $200.
So, whether for 2012 or 2013, the benefit of paying a dividend is more than $7500.
CASES WHERE A SALARY IS PREFERABLE
The decision to receive a salary or a dividend should not be based solely on a tax calculation. In all cases, the situation of the shareholder and that of the joint stock company must be taken into account. For the shareholder, the ancillary benefits of receiving a salary could be greater than the savings realized by the SPA. On the other hand, additional funds in the SPA may be necessary to keep it running smoothly.
In some cases, however, it may be desirable to pay a salary:
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Pregnancy. When a couple is planning to have a child, it’s a good idea to pay a salary to maximize the amounts received during maternity leave, parental leave or both.
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Childcare expenses. When child care expenses are incurred, it’s important that both spouses have employment income, since the deduction for these expenses must be claimed by the spouse with the lower qualifying income. Dividends are not considered eligible income.
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Group insurance plan. If the SPA offers a group insurance plan to its employees and it would be advantageous for the shareholder to participate, it would be preferable for him to pay himself a salary. The shareholder may be uninsurable, so group insurance may be the only way to obtain disability coverage.
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Scientific research and experimental development (SR&ED). If the SPA carries out activities that qualify for an SR&ED credit, and the shareholder participates in them, the payment of a salary will enable the credit to be claimed. Credits for SR&ED activities can amount to over 80% of salary.
THREE SITUATIONS REQUIRING ANNUAL ANALYSIS
Company tax liabilities
If the company has tax debts and is unable to repay them, the tax authorities may require the shareholder to repay the dividends received.
The payment of a dividend is considered an unrequited payment, whereas a cash outflow in the form of salary is not.
Quebec Pension Plan contributions
The payment of a dividend implies that the shareholder forgoes the benefit of contributing to the Quebec Pension Plan. Here are a few questions to ask yourself to determine whether it’s worthwhile to contribute to the QPP:
- What is the value of this contribution in relation to the annuity the shareholder will receive at retirement?
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How many years until retirement?
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What is the shareholder’s investment profile? Will the same amount invested personally give him a better pension?
RRSP
It’s often said that contributing to an RRSP can reduce taxes. For a shareholder, contributing to an RRSP means no tax savings, but rather an additional cash outflow for the company.
Here are a few points to consider before making the right decision:
- Income splitting with family members is possible when funds are held in a corporation.
- RRSPs are part of the family estate, unlike company shares.
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This article was published: les Affaires |
http://bit.ly/RkouPE
| October 20, 2012
http://bit.ly/RkouPE
| October 20, 2012
