Salary vs. Dividend: What’s the Best Way to Pay Yourself from a Rental Income Corporation?

If you own a corporation that generates rental income, one of the big decisions you’ll need to make is how to pay yourself. You have two main options: take a salary or pay yourself through dividends. Both come with different tax implications and financial impacts. Understanding how they work will help you make the best decision for your situation. Let’s break it down in simple terms.

1. Understanding the Basics

A corporation with rental income, like a property management or real estate investment business, pays taxes on its earnings. As a shareholder, you have two main ways to take money out of the company:

• Salary: A salary is paid to you as an employee of the corporation and is treated like regular employment income.

• Dividends: Dividends are paid from the corporation’s profits after taxes and are taxed differently than a salary.

So, how do you decide which is better? Let’s look at the pros and cons of each option.

2. Pros and Cons of Salary

Pros:

• Tax Deduction for the Corporation: Paying yourself a salary reduces the corporation’s taxable income because it’s considered a business expense. This means the company pays less corporate tax.

• RRSP Contributions: Your salary creates Registered Retirement Savings Plan (RRSP) contribution room, allowing you to save more for retirement while deferring taxes.

• CPP Contributions: Paying yourself a salary requires contributing to the Canada Pension Plan (CPP), which builds up your CPP retirement benefits.

Cons:

• Higher Personal Taxes: Salaries are taxed at your personal income tax rate, which could be high depending on your total income. In Canada, the more you earn, the higher your tax rate.

• CPP Costs: Both you (as an employee) and your corporation (as the employer) have to make CPP contributions, which adds to the payroll cost.

3. Pros and Cons of Dividends

Pros:

• Lower Personal Taxes: Dividends benefit from the Dividend Tax Credit, which lowers your personal tax rate on dividend income. In many cases, this can be more tax-efficient than taking a salary.

• No CPP Contributions: You don’t have to pay into CPP on dividend income, so you save money by avoiding these contributions.

• Flexible Payments: Dividends don’t need to be paid on a regular schedule. You can pay yourself dividends when it’s most beneficial for tax purposes or cash flow.

Cons:

• No RRSP Contribution Room: Dividends don’t increase your RRSP contribution room, which could limit your ability to save tax-free for retirement.

• No CPP Benefits: Since you’re not contributing to CPP, you won’t build up any CPP benefits for retirement, which could be a drawback if you’re relying on CPP for part of your retirement income.

• Paid from After-Tax Profits: Dividends are paid from profits that have already been taxed at the corporate level, so there’s no immediate tax deduction for the corporation like there is with salary.

  
  

4. Tax Considerations for Rental Income Corporations

Rental income earned by a corporation is typically considered passive income, which is taxed at a higher corporate tax rate (up to 50%) compared to active business income. This means that your corporation may end up paying more in taxes on its rental profits before it can pay dividends to you.

The good news is that Canada’s tax system includes mechanisms like the Dividend Tax Credit to prevent double taxation. This means you won’t be taxed twice at full rates on the same income, but you’ll still need to consider whether salary or dividends provide better after-tax results for your personal situation.

5. Which One is Right for You?

Choose Salary If:

• You want to reduce your corporation’s taxable income.

• You need RRSP contribution room for retirement savings.

• You’re looking to build up CPP benefits for your retirement.

• You prefer steady, predictable income.

Choose Dividends If:

• You’re aiming for a more tax-efficient way to get paid, especially if your personal income tax rate is high.

• You want to avoid the costs of CPP contributions.

• You want flexibility in how and when you get paid.

6. Can You Use Both?

Absolutely! Many business owners choose a mix of salary and dividends to get the best of both worlds. You might take a smaller salary to create RRSP contribution room and build CPP benefits, and then pay yourself dividends to take advantage of lower tax rates. This blended approach can provide flexibility and maximize your after-tax income.

7. Final Thoughts

When deciding between salary and dividends for a corporation with rental income, there’s no one-size-fits-all answer. The best option depends on your personal financial goals, tax situation, and long-term retirement plans. Consulting a tax professional or accountant can help you tailor the perfect strategy that fits your needs.

By understanding the pros and cons of each method, you can make an informed decision to minimize taxes and keep more of your hard-earned rental income in your pocket!

It’s essential to consult with a tax advisor or accountant to create a tailored plan that fits your specific situation and goals. Get in touch today to book your free consultation.

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