Should I avoid CPP premiums by paying myself dividends

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By Julie Cazzin with Andrew Dobson

Q: I’m beginning my very own firm and would love your ideas on taking a wage versus dividends. I’m considering of going the dividend route merely to keep away from Canada Pension Plan (CPP) premiums. What are the professionals and cons of this? — Jason in Alberta

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FP Solutions: The very first thing I’d think about, Jason, is whether or not to include within the first place. You could be self-employed, earn revenue as a sole proprietor and report it in your personal tax return. For those who incorporate, this comes with authorized charges, accounting charges and extra bookkeeping.

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Widespread causes to include are legal responsibility safety, involving shareholders, and if you happen to anticipate to earn extra revenue than is required in your life-style bills. The final level may end up in critical tax financial savings if you happen to can retain a few of your revenue corporately slightly than withdrawing it personally. Tax deferral could be greater than 40 per cent when evaluating company tax charges to the highest personal tax rates in some provinces.

The choice to take a wage or dividends includes an understanding of company and private tax integration. If an owner-manager pays out all their company revenue as wage, it will be much like in the event that they earned all of it personally within the first place. The company would declare a tax deduction for the revenue paid out, so the company would don’t have any taxable revenue, and the worker would pay tax on the revenue as a substitute.

Dividends are a bit completely different. A dividend is a fee of after-tax revenue to a shareholder. A small-business company usually pays between eight per cent and 16 per cent tax on its revenue. It might then pay a dividend to a shareholder that’s taxed at a decrease charge than wage, usually about the identical eight per cent to 16 per cent decrease, however the charge differential could be much less or extra relying on a taxpayer’s revenue, deductions and credit.

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The decrease tax charge on dividends is supposed to account for the company tax already paid. Company-personal tax integration will not be good, however fairly shut. The purpose being that an owner-manager needs to be practically detached between wage and dividends from an all-in tax perspective.

It’s doable for a brand new enterprise to not pay out revenue to workers and/or shareholders in its early days, particularly when beginning up or earlier than turning into worthwhile. Since paying wage includes registering a payroll account with the Canada Revenue Agency and remitting CPP contributions and revenue tax to the CRA, it may be extra complicated for brand new enterprise homeowners.

Dividends could be easier because the company pays them out with out having to fret about withholding tax and authorities remittances. The disadvantage is you may find yourself spending cash that has not had adequate (or any) tax withheld and being stunned by your tax invoice at year-end.

If you wish to keep away from CPP premiums, paying out dividends would accomplish this. That stated, avoiding CPP is not going to essentially put you forward. CPP could also be thought of a payroll tax, however it isn’t precisely a tax. It’s a contribution to a pension plan that can pay you an revenue sooner or later.

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The implied charge of return when a enterprise proprietor has to pay the employer and worker CPP contributions is probably not excessive, however it’s nonetheless successfully a profit. It’s also a type of pressured financial savings that somebody won’t in any other case replicate on their very own.

The advantages of selecting a wage transcend extra predictable tax funds and CPP advantages. Wage additionally counts as earned revenue and creates registered retirement savings plan (RRSP) contribution room, whereas dividends don’t. Wage additionally has the potential for simpler revenue verification when making use of for credit score, can qualify for sure tax credit such because the Canadian Employment Credit score, and permits for sure deductions like child-care bills.

Relying on the rationale behind your resolution, Jason, it might not make sense to contribute to CPP. This can be the case in case you are a disciplined and aggressive self-directed investor with low funding charges. A shortened life expectancy could also be another excuse. You will have already maximized CPP based mostly in your previous contributions or produce other defined-benefit pension income that’s adequate to fulfill your revenue wants.

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Regardless, I consider that will probably be prudent to evaluation the advantages of CPP forward of tax financial savings as a result of avoiding CPP can present short-term financial savings on the expense of a long-term discount in retirement income.

Andrew Dobson is a fee-only, advice-only licensed monetary planner (CFP) and chartered funding supervisor (CIM) at Objective Financial Partners Inc. in London, Ont. He doesn’t promote any monetary merchandise in any way. He could be reached at adobson@objectivecfp.com.

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