6 considerations between salary and dividend that you need to know

The decision between taking a salary or receiving dividends is an important consideration for business owners, as it has implications for both personal income and the overall financial health of the business. Let's explore the key aspects of salary versus dividends for business owners:

1. Tax Implications:

   • Salary: Salaries are considered a business expense and are deductible from the company's taxable income. However, the business and the individual owner must pay payroll taxes, including Social Security and Medicare contributions.

   • Dividends: Dividends are paid from after-tax profits. While they are not tax-deductible for the business, they may be taxed at a lower rate for the recipient, depending on the individual's tax bracket.

2. Flexibility and Control:

   • Salary: Paying yourself a salary provides a regular and predictable income. It can be beneficial for personal budgeting and financial planning.

   • Dividends: Dividends offer more flexibility. Business owners can choose when and how much to distribute based on the company's financial performance. This flexibility can be particularly advantageous during profitable years.

3. Retirement Planning:

   • Salary: Salary contributes to CPP which are funds that can be used when you hit retirement.

   • Dividends: While dividends don't contribute to CPP, they can still be part of a business owner's overall retirement strategy. However, they don't provide the same tax advantages for retirement account contributions.

4. Credibility and Borrowing Capacity:

   • Salary: A consistent salary may enhance your credibility when applying for personal loans or mortgages since it reflects a stable income.

   • Dividends: Lenders may view dividend income as less reliable since it depends on the business's profitability, which can fluctuate.

5. Legal and Regulatory Considerations:

   • Salary: Drawing a salary typically involves more formalities, such as adhering to employment laws, withholding taxes, and complying with labor regulations.

   • Dividends: Distributing dividends requires adherence to company bylaws and legal regulations. It is crucial to ensure that the business has sufficient retained earnings to cover dividend payments.

6. Impact on Business Valuation:

   • Salary: A higher salary may reduce the company's net profit and, consequently, its valuation. This can affect the business's market value, especially if potential buyers or investors focus on profitability metrics.

   • Dividends: While dividends also reduce retained earnings, they may be viewed more favorably in certain situations, as they can signal a return on investment for shareholders.

Ultimately, the decision to take a salary or dividends—or a combination of both—depends on various factors, including the business's financial performance, the owner's financial goals, and the regulatory environment. Consulting with financial advisors and tax professionals is advisable to make informed decisions tailored to the specific circumstances of the business and the owner.