Liliane Fortier, Les Affaires 20-10-2012
When entrepreneurs decide to incorporate, this means that, as shareholders, they can choose how they wish to be remunerated. Is it better to receive a dividend or a salary? How will the tax changes planned by the new government affect the answer to this question?
To determine the best form of remuneration, shareholders have to know the after-tax amount they will need in order to maintain their lifestyle. The best scenario will reduce after-tax cash outflows for the corporation.
In the case of a salary, the corporation must pay benefits—i.e., the employer’s share of contributions to Quebec’s pension plan (the RRQ), the Quebec Parental Insurance Plan, and the provincial health-services fund (Fonds des services de santé).
Salary and benefits are deductible for the corporation, with the salary being taxable in the hands of the shareholder.
Dividends are not deductible for the corporation. Shareholders must declare this income for tax purposes, taking account of dividend gross-ups and dividend tax credits. They must also pay the health-services fund.
In principle, the federal tax system uses “integration” to ensure that the income tax collected, where that income is earned by a company and distributed to shareholders as dividends, equals that which would be collected if the income had been earned directly by an individual. Since the principles of integration are established using the highest marginal tax rate applicable to individuals, integration is not perfect in cases where shareholders are not already taxed at that rate.
Gross-Up for 2013
In 2012, for example, someone who needs an annual after-tax income of $80,000 will need a salary of $127,250 or a dividend of $100,500.
For a corporation, the net after-tax cost of paying the salary will be $108,200, as compared to $100,500 for the dividend. From the corporation’s viewpoint, therefore, it is more advantageous to pay a dividend. (These calculations have been made based on the hypothesis that the company has a tax rate of 19%, or, in other words, that its taxable income is below $500,000.)
For 2013, salaries and dividends would have to be increased to $128,500 and $101,400, respectively, in order to take account of the hike in the tax rate for income in excess of $100,000. The net after-tax cost for the corporation would be $109,200 for the salary, and $101,400 for the dividend. The corporation does not have to adjust the salary or dividend to help the shareholder pay the health-services fund contribution, as,
at this level, that contribution would be $200.
Whether for 2012 or 2013, the advantage of paying a dividend amounts to more than $7,500.
CASES IN WHICH A SALARY IS PREFERABLE
The decision to receive a salary or a dividend should not be based solely on tax calculations. In all cases, the situation of the shareholder and the corporation must be examined. For the shareholder, the advantages of receiving a salary could be greater than the savings made by the corporation. On the other hand, the additional funds in the corporation may be required for it to operate efficiently.
A salary may be preferable in the following instances:
- Pregnancy. Where a couple is expecting a child, it would be wise to opt for a salary in order to maximize the amounts received during maternity leave, paternity leave, or both.
- Childcare expenses. When childcare expenses are incurred, it is important that both spouses have employment income, as the deduction of these costs must be claimed by the partner with the lowest eligible income. Dividends are not considered eligible income.
- Group insurance plans. If the corporation offers its employees a group insurance plan and it would be advantageous for the shareholder to participate, the latter would be better off paying him/herself a salary. If the shareholder is not insurable, the group plan might be the only way to obtain disability insurance.
- Scientific research and experimental development (SRED). If the corporation conducts activities qualifying for a SRED credit and the shareholder participates in those activities, receiving a salary makes it possible to claim this credit. Credits for SRED activities can amount to more than 80% of the salary.
SITUATIONS REQUIRING AN ANNUAL ANALYSIS
The Company’s Tax Liability
If the company has a tax liability and is unable to pay, the authorities could require the shareholder to refund dividends received. The payment of a dividend is considered a payment without consideration, but a disbursement in the form of a salary is not.
The payment of a dividend means the shareholder relinquishes the benefits of contributing to Quebec’s pension plan. Below are a few questions you should ask to determine if such contributions would be worthwhile:
- What is the value of such contributions in relation to the annuity you, as a shareholder, could receive upon retirement?
- How many years do you have until retirement?
- What is your investor profile? Would the same amount invested personally give you a better guaranteed income?
You often hear that RRSP contributions can reduce your income tax payable. For shareholders, RRSP contributions do not involve any tax savings, involving instead an additional cash outflow for the company.
Here are certain points to consider in making your decision:
- It is possible to split income with members of the same family when the funds are in a company.
- Unlike company shares, RRSPs form part of the family patrimony.
Liliane Fortier, CPA, CA, LL.M. Fisc. Partner – Taxation Services – Demers Beaulne – 514 878-0258 – firstname.lastname@example.org