Dividend or Paycheck?

Dividend or Paycheck?

Since I have owned my own business for a number of years, one of the things I have always tried to do is make the most of the money I have by dividing my income payments into dividends and salaries in a way that gives me the best tax advantage. Therefore, you might be able to achieve the ideal balance between the dividend amount you withdraw, the business tax you must pay on profits before receiving a dividend, and the company salary.

Although this is not a fixed formula, as it varies from country to country and sometimes even from province to province, you can determine the best balance for you regardless of where you live by following some basic guidelines. And by doing this, you can absolutely get the most money out of your money while paying the least amount of taxes.

The first step is to figure out the dividend tax formula that is used to figure out your personal tax. Up to a certain amount of dividends paid, you may receive no tax or a low tax rate in some places. Then, an additional tax rate for sums above that. For instance, on my personal tax side, dividends are tax-free for the first $40,000 paid out where I currently live. Additionally, the percentage increases above that, but typically only for sums exceeding $40,000. The second step is to determine your personal tax rate scales based on income levels.

Again, the percentages may vary, but I’ve found that in most countries, your personal taxes are assessed in a stepped manner—essentially designed to tax the wealthy more—with percentages increasing as your income rises. For instance, if you have $50,000 per year available to pay yourself (not accounting deductions), the tax burden will be ($15,000 x 0%=$0 tax) + ($25,000 – $15,000=$10,000 x 12%=$1,200 tax) + ($35,000 – $25,000=$10,000 x 19%=$1,900 tax) + ($50,000 – $35,000=$15,000 x 35%=$5,250 tax), leaving a total tax bill of $8,350 on the entire $50,000 This amounts to $41,650 after taxes.

The third step is to determine the percentages of your business’s taxes. Typically, this is a fixed percentage that must be paid on all profits before you can receive a dividend. I propose setting the business tax rate at 30% to illustrate the balancing act. With this in mind and the fact that dividends are tax-free up to $40,000 (as shown in the previous example), you could save 5% on taxes on the top $15,000 of your salary.

Therefore, if you want to take advantage of this savings, pay yourself a salary of $35,000 rather than $50,000, and your personal tax will be $1,200 plus $1,900, which equals $3,100. The tax on the business side would then be $4,500.00 if you calculated the 30% business tax before you took the $15,000 dividend. This means that instead of $8,350, the total amount of tax due on the same $50,000 will only be $7,600 ($3,100 x $4,500). If you keep in mind that dividends up to $40,000 are exempt from tax, you will save $750 in taxes by simply declaring a portion of your salary as a dividend. Additionally, this means that you will now receive $42,400.

Having a quick conversation with your accountant to make sure you’ve done the math right might be helpful, but regardless, I would recommend taking this into consideration, allocating your income accordingly, and then figuring out the best advantage strategy for you..