Year-End Bonuses vs Dividends: Which Is Better for Your Company’s Tax Bill? – A Complete Guide by a Montreal CPA Firm Near You

Choosing between a year-end bonus and dividends in Canada is one of the most

important decisions for corporation owners and shareholders. The choice affects both

corporate tax and personal tax, cash flow, payroll contributions, RRSP contribution

room, CPP entitlement, and long-term financial planning. Many business owners believe

bonuses always reduce taxes because they are deductible, while others assume

dividends are better because they avoid payroll costs. In reality, neither option is

universally better. The right choice depends on corporate profitability, your marginal tax

rate, the Small Business Deduction (SBD), cash availability, and your long-term goals.

Understanding the tax implications of year-end bonuses vs dividends in Canada

ensures you minimize your overall tax burden while staying compliant with CRA rules.

Legal and Regulatory Framework

The tax treatment of bonuses and dividends is governed by several sections of the

Income Tax Act.

Bonuses

• Treated as employment income under section 5.

• Deductible to the corporation if “reasonably expected to be paid within 180 days” after

year-end (section 78(4)).

• Subject to CPP, EI (if eligible), and income tax withholdings.

• Generate RRSP room (18% of earned income).

• Must be reported on a T4 slip.

Dividends

• Paid out of after-tax corporate profits.

• Governed by sections 82 and 121, which establish the gross-up and dividend tax

credit system.

• Do not create RRSP room.

• Not subject to CPP or EI.

• Reported on a T5 slip.

• Classified as eligible or non-eligible depending on the corporation’s income type.

Corporate Tax Impact

• Bonuses reduce corporate taxable income, potentially increasing access to the

Small Business Deduction.

• Dividends do not reduce corporate taxes, but integrate personal and corporate

taxation.

These rules form the legal foundation for deciding between year-end bonuses vs

dividends in Canada.

Key Court Decisions

Several court rulings shape CRA’s interpretation of bonuses and dividends.

In Krauss v. The Queen, CRA challenged excessive bonuses paid to shareholders; the

court allowed deductions but emphasized the need for reasonableness.

In McClarty v. Canada, the court reinforced that bonuses must be accrued correctly and

paid within the 180-day limit to be deductible.

In Drew v. Canada, CRA successfully reclassified certain payments as salary instead of

dividends where the corporation attempted to avoid payroll obligations.

In Neuman v. Canada, the Supreme Court ruled that dividends paid to family members

must reflect economic and corporate reality, influencing TOSI compliance for dividends.

These decisions highlight the importance of proper documentation and compliance

when deciding between bonuses and dividends.

Why CRA Targets This Issue

CRA frequently reviews compensation structures because business owners often

attempt to minimize tax improperly. CRA scrutinizes:

• corporations paying only dividends to avoid CPP

• excessive bonuses meant to eliminate taxable corporate income

• dividends paid to family members who do not meet TOSI exemptions

• bonuses accrued at year-end but not actually paid within 180 days

• dividends paid without proper corporate resolutions

• compensation structures inconsistent with corporate profitability

CRA reviews T4s, T5s, shareholder loan accounts, and corporate resolutions to detect

non-compliant payments. Understanding bonuses vs dividends reduces audit risk.

Mackisen Strategy

At Mackisen CPA Montreal, we create customized compensation strategies for owner-

managers, optimizing bonuses and dividends to minimize both corporate and personal

tax. Our structured approach includes:

• analyzing corporate taxable income and determining whether a year-end bonus

reduces tax advantageously

• evaluating personal marginal tax rates to determine the most cost-effective mix

• planning dividends within retained earnings and legal requirements

• structuring bonuses to create RRSP room when beneficial

• calculating CPP impact and long-term retirement considerations

• preparing proper T4/T5 filings and corporate resolutions

• coordinating compensation timing with fiscal year-end and cash flow

• implementing multi-year strategies to maximize overall tax efficiency

Our methodology ensures that year-end bonuses vs dividends decisions are tax-

efficient, compliant, and aligned with long-term financial goals.

Real Client Experience

A corporation with high taxable income planned to pay only dividends. After analysis,

we recommended issuing a year-end bonus to reduce taxable corporate income and

maintain access to the Small Business Deduction. The owner saved significant tax.

Another client relied on bonuses and paid almost no dividends, missing opportunities for

tax-efficient distribution. We added non-eligible dividends into the compensation plan,

lowering overall tax.

A third client accrued bonuses but failed to pay them within 180 days. CRA denied the

deduction. We corrected the structure for future years and recovered portions of the

deduction through amended filings.

These cases highlight the importance of strategic decision-making when choosing

bonuses vs dividends in Canada.

Common Questions

Business owners often ask whether they should take only dividends. This may be tax-

efficient but eliminates RRSP room and CPP contributions.

Others ask whether bonuses can reduce corporate tax to zero. Yes, if planned correctly,

but CRA may question excessive amounts.

Some ask whether dividends are always cheaper. Not always—high-income individuals

may pay more tax on dividends than salary.

Another question: Can a mix of both be used? Yes—most optimal strategies involve a

hybrid approach.

These questions highlight why understanding year-end bonuses vs dividends in Canada

is essential.

Why Mackisen

With more than 35 years of combined CPA experience, Mackisen CPA Montreal helps

entrepreneurs build tax-efficient compensation plans that maximize wealth and minimize

taxes. Whether issuing a year-end bonus, paying dividends, or structuring a customized

hybrid, our expert team ensures precision, transparency, and protection from audit risk.