Paying Yourself as a Business Owner: T4 Salary vs. T5 Dividends — The Ultimate Guide

Deciding how to pay yourself as a business owner — through a T4 salary or T5 dividends — is one of the most important financial decisions you'll make. Both options have unique benefits and drawbacks, and the right choice depends on your tax situation, retirement goals, and cash flow needs. In this guide we break down the pros and cons of each method, provide real-life examples, and explain what happens in the event of bankruptcy.

What is a T4 salary?

A T4 salary is employment income paid to you as a business owner or employee. It's reported on a T4 slip and is subject to income tax, CPP contributions, and potentially EI premiums.

Pros of paying yourself a salary (T4)

1. CPP contributions & pension benefits. When you pay yourself a salary, you and your company contribute to the Canada Pension Plan (CPP). This helps you build up government pension benefits for retirement. While CPP contributions increase your costs, they provide long-term financial security.
   Example: if you pay yourself a $60,000 salary, both you and your company contribute to CPP, helping you qualify for future pension benefits.
2. RRSP contribution room. Salary counts as earned income, which creates RRSP contribution room. This allows you to save for retirement while reducing your taxable income through RRSP contributions.
   Example: a $60,000 salary creates $10,800 in RRSP contribution room (18% of earned income), giving you a tax-advantaged way to save for retirement.
3. Predictable tax withholding. With a salary, income tax is deducted at source, meaning you won't face a large tax bill at year-end. This makes tax planning easier and more predictable.
   Example: if you earn $5,000 per month, your payroll system will automatically deduct taxes, CPP and EI, leaving you with a predictable net income.
4. Easier loan & mortgage approval. Lenders prefer steady T4 income when evaluating loan applications. A consistent salary makes it easier to qualify for mortgages, business loans, or other financing.
   Example: if you apply for a mortgage, banks will look at your T4 income to determine your borrowing capacity. A steady salary makes you a more attractive borrower.
5. Reduces corporate taxes. Salary is a deductible business expense, which lowers your corporation's taxable income. This can result in significant corporate tax savings.
   Example: if your corporation earns $100,000 and pays you a $60,000 salary, the taxable income drops to $40,000, reducing the corporate tax owed.

Cons of paying yourself a salary (T4)

1. Mandatory CPP contributions. Both you and your company must pay CPP contributions, which can increase your costs. For some business owners this can feel like an unnecessary expense.
2. Less flexibility. Salaries must be paid regularly, for example bi-weekly or monthly, whereas dividends can be paid at any time. This can limit your cash flow flexibility.
   Example: if your business has a slow month, you still need to pay yourself a salary, which could strain your finances.
3. Higher personal tax rates. Salary is taxed at regular personal tax rates, which can be higher than the tax rates on dividends. This could mean paying more in taxes, depending on your income level.
   Example: a $60,000 salary may be taxed at 20–30%, while dividends could be taxed at a lower rate due to the dividend tax credit.
4. More administrative work. Payroll requires setting up a system, handling source deductions, remitting taxes, and filing T4 slips. This can be time-consuming and may require professional help.

What about T5 dividends?

Dividends are payments made to shareholders from the company's profits. They're taxed differently than salary and offer more flexibility, but they come with their own set of pros and cons.

Pros of paying yourself dividends (T5)

1. Lower personal tax rates. Dividends are taxed at a lower rate than salary due to the dividend tax credit. This can result in significant tax savings, especially for higher-income earners.
   Example: a $60,000 dividend may be taxed at a lower rate than a $60,000 salary, saving you money.
2. No CPP contributions. Dividends don't require CPP contributions, saving you and your company money. However, this also means you won't build up CPP benefits for retirement.
   Example: paying yourself $60,000 in dividends means no CPP contributions, saving you thousands of dollars.
3. Flexibility in payments. Dividends can be paid at any time, giving you more control over your cash flow. You can pay yourself when the business is doing well and hold off during slower periods.
4. Less administrative work. Dividends don't require payroll setup or source deductions. You'll still need to file a T5 slip, but the administrative burden is much lower than with salary.

Cons of paying yourself dividends (T5)

1. No RRSP contribution room. Dividends don't count as earned income, so they don't create RRSP contribution room. If retirement savings are a priority, this could be a disadvantage.
   Example: a $60,000 dividend won't create any RRSP contribution room, limiting your ability to save for retirement.
2. No CPP or EI benefits. Since dividends don't require CPP contributions, you won't build up CPP benefits. Additionally, you won't qualify for Employment Insurance (EI) if your business fails.
3. Harder to qualify for loans. Lenders prefer steady T4 income when evaluating loan applications. If you only pay yourself dividends, it may be harder to qualify for a mortgage or business loan.

T4 salary vs. T5 dividends: side-by-side comparison

Which one should you choose?

The choice between salary and dividends depends on your financial goals:

• Choose T4 (salary) if you want CPP benefits, RRSP contribution room, and steady income. This is ideal for retirement planning and loan applications.
• Choose T5 (dividends) if you want lower taxes, flexibility in payments, and minimal administrative work. This is ideal for tax efficiency and cash flow control.
• Many business owners use a mix of both to balance tax savings, retirement planning, and cash flow flexibility.

What happens in bankruptcy?

If your business faces bankruptcy, how you've paid yourself can have significant consequences:

• Salary (T4): salaries are considered employee wages, which may have priority in bankruptcy proceedings. This means you're less likely to face claw backs from creditors. Additionally, if you've paid into EI, you may qualify for Employment Insurance benefits if your business fails.
• Dividends (T5): dividends are considered profit distributions, and if they were paid while the company was insolvent, they could be reversed by creditors. Directors may also be held personally liable for wrongful distributions.

Example: if your company goes bankrupt and you've paid yourself $50,000 in dividends while the company was insolvent, creditors could demand that money back. On the other hand, if you paid yourself a salary, it's less likely to be clawed back.

Conclusion

Deciding between a T4 salary and T5 dividends is a key financial decision for business owners. A salary offers stability, retirement benefits, and easier access to loans, but it comes with higher taxes and more administrative work. Dividends offer tax efficiency and flexibility, but they don't contribute to CPP or RRSPs and can be riskier in bankruptcy.

Many business owners find that a mix of salary and dividends works best, allowing them to balance tax savings, retirement planning, and cash flow needs. If you're unsure, speak with a tax professional to create a strategy tailored to your business.

This article is general information for Canadian taxpayers and is not tailored tax advice. Rules, rates and thresholds change, and your own circumstances matter — please confirm anything material before acting on it.