FP Answers: Should I pay myself dividends from my company to avoid CPP premiums?

financialpost.com:

By Julie Cazzin with Andrew Dobson

Q: I’m starting my own company and would like your thoughts on taking a salary versus dividends. I’m thinking of going the dividend route simply to avoid Canada Pension Plan (CPP) premiums. What are the pros and cons of this?

FP Answers: The first thing I would consider, Jason, is whether to incorporate in the first place. You can be self-employed, earn income as a sole proprietor and report it on your personal tax return. If you incorporate, this comes with legal fees, accounting fees and additional bookkeeping.

Common reasons to incorporate are liability protection, involving shareholders, and if you expect to earn more income than is needed for your lifestyle expenses. The last point can result in serious tax savings if you can retain some of your profit corporately rather than withdrawing it personally. Tax deferral can be more than 40 per cent when comparing corporate tax rates to the top personal tax rates in some provinces.

The decision to take a salary or dividends involves an understanding of corporate and personal tax integration. If an owner-manager pays out all their corporate income as salary, it would be similar to if they earned it all personally in the first place. The corporation would claim a tax deduction for the income paid out, so the corporation would have no taxable income, and the employee would pay tax on the income instead.

Dividends are a bit different. A dividend is a payment of after-tax profit to a shareholder. A small-business corporation typically pays between eight per cent and 16 per cent tax on its income. It can then pay a dividend to a shareholder that is taxed at a lower rate than salary, generally about the same eight per cent to 16 per cent