Introduction
When operating as an incorporated medical professional in Canada, one of the most critical financial decisions is how to pay yourself from your corporation. The two primary options—salary and dividends—each come with distinct advantages and drawbacks. While dividends were once considered a more tax-efficient method, recent tax regulations and long-term financial planning considerations strongly favor salary payments for most physicians.
This article examines the key differences between salary and dividends, their tax implications, and why salary remains the preferred choice for medical professionals.
1. What is a Salary?
A salary is a fixed, recurring payment made by your corporation to you as an employee. Salaries are subject to payroll deductions such as income tax, CPP (Canada Pension Plan), and other withholdings.
Pros of Taking a Salary
- Creates RRSP Contribution Room: Salary payments generate Registered Retirement Savings Plan (RRSP) contribution room, allowing physicians to save for retirement with tax-deferred growth.
- Predictable Tax Planning: Salaries provide consistent income, making tax planning easier and more structured.
- Eligibility for CPP Benefits: Contributions to the Canada Pension Plan (CPP) provide future retirement benefits.
- Allows for Additional Pension Contributions: A salary enables access to pension plans beyond RRSP limits, such as an Individual Pension Plan (IPP) for incorporated professionals.
- Better for Loan Applications: Lenders favor stable, predictable income when approving mortgages or business loans.
Cons of Taking a Salary
- Higher Administrative Requirements: Salaries require setting up payroll, remitting taxes, and managing compliance with CRA rules.
- Less Flexibility: Unlike dividends, a salary must be structured and paid regularly, which may require more planning.
2. What are Dividends?
Dividends are payments from a corporation’s after-tax profits to its shareholders. They do not require payroll deductions and are taxed at a lower personal rate than salary.
Pros of Taking Dividends
- Greater Flexibility: Unlike salaries, dividends can be paid at any time and in any amount, making cash flow management easier.
- Lower Administrative Costs: There is no need to manage payroll or remit payroll taxes.
- Potential Tax Deferral: If dividends are deferred until a lower-income year, tax savings may be realized.
Cons of Taking Dividends
- No RRSP Contribution Room: Dividend income does not generate RRSP contribution eligibility, limiting retirement savings options.
- No Canada Pension Plan (CPP) Benefits: Without salary contributions, medical professionals do not qualify for CPP retirement benefits.
- Potentially Higher Corporate Tax Burden: Since dividends are paid from after-tax corporate income, the corporation must first pay corporate tax before distributing dividends.
3. The Myth of Dividends Being More Tax Efficient
Historically, dividends were perceived as a more tax-efficient option for incorporated professionals due to their lower tax rates. However, in practice, the tax savings are often overstated.
- Lost RRSP Contribution Room: The long-term tax savings from RRSP contributions and compounding investment growth outweigh the marginal tax benefits of dividends.
- Higher Corporate Taxes: Dividends require the corporation to pay higher corporate tax on retained earnings, diminishing their overall efficiency.
- Minimal Personal Tax Savings: In an ideal scenario, dividends may offer 1-3% lower taxes annually, but this benefit is often negated by lost pension and retirement benefits.
At Tax Partners, we’ve observed that 90%+ of medical professionals benefit more from a salary-first approach. While there are occasional cases for a dividend top-up, these situations are rare and require proper planning.
4. Which is Better for Medical Professionals?
For most incorporated physicians, a salary-based strategy is the best approach. Here’s why:
- It provides a structured tax strategy, making it easier to manage cash flow and tax liabilities.
- It enables long-term retirement planning through RRSP contributions and pension savings.
- It allows physicians to benefit from CPP and additional retirement income options.
Incorporated doctors should work with a tax advisor to determine the most effective compensation strategy based on their individual financial goals.
Rare Situations Where Dividends May Be Useful
- Short-term income deferral strategies in low-income years.
- Retirement or practice transition planning, where a mix of salary and dividends optimizes taxation.
- Specialized tax planning for family members receiving dividends in lower tax brackets.
Conclusion: A Salary-First Approach for Long-Term Financial Success
While dividends offer flexibility, the advantages of salaries—structured tax planning, RRSP eligibility, CPP benefits, and long-term financial security—far outweigh the marginal tax savings of dividends.
Key Takeaways:
- Salaries create RRSP contribution room, enabling long-term tax-deferred growth.
- A salary-first approach simplifies tax planning and provides retirement benefits.
- Dividends do not contribute to CPP or RRSP, limiting future financial security.
- A combination of salary and dividends may be appropriate in specific cases but requires careful planning.
At Tax Partners, we specialize in helping Canadian medical professionals maximize their financial efficiency. Contact us today to develop a tax strategy tailored to your career and financial goals.
This article is written for educational purposes.
Should you have any inquiries, please do not hesitate to contact us at (905) 836-8755, via email at [email protected], or by visiting our website at www.taxpartners.ca.
Tax Partners has been operational since 1981 and is recognized as one of the leading tax and accounting firms in North America. Contact us today for a FREE initial consultation appointment.