As a small business owner in the construction industry, you have the option to choose how to pay yourself—through a salary or dividends. Each payment method has its pros and cons, and it's important to understand them before making a decision. This blog post will discuss the advantages and disadvantages of taking dividends instead of a salary in the context of a small construction business.
Pros of Taking a Dividend
Tax Efficiency: Dividends are generally more tax-efficient than salaries. In most jurisdictions, dividends are taxed at a lower rate than personal income. This means that as a business owner, you may be able to pay less tax overall by taking dividends instead of a salary.
Flexibility: Dividends offer more flexibility than a fixed salary. As a business owner, you can decide when and how much to pay yourself in dividends, allowing you to better manage your cash flow and personal finances.
Lower Payroll Taxes: When you pay yourself a salary, you're also responsible for payroll taxes like Social Security and Medicare contributions. However, when you pay yourself through dividends, these taxes are not applicable. This can save you a significant amount of money, especially if you're a high-income earner.
Retained Earnings: By choosing to take dividends instead of a salary, you can leave more money in your business to reinvest and grow. This can be particularly helpful in the construction industry, where cash flow can be tight due to the cyclical nature of projects.
Cons of Taking a Dividend
No Employment Benefits: When you pay yourself a salary, you're considered an employee of your company and are entitled to certain benefits like workers' compensation and unemployment insurance. However, when you pay yourself through dividends, you're not considered an employee, and you may not be eligible for these benefits.
Limited Retirement Savings: As a salaried employee, you can contribute to a retirement plan like a 401(k) or an IRA. However, when you take dividends instead of a salary, you may not have access to these tax-advantaged retirement savings options.
Less Stable Income: Since dividends depend on the profitability of your business, your income may fluctuate more than it would with a stable salary. This can make budgeting and planning for the future more challenging.
Potential Legal and Financial Risks: Depending on your jurisdiction, paying yourself solely through dividends may expose you to increased scrutiny from tax authorities. They may view this as an attempt to avoid payroll taxes, and you may be required to prove that your dividend payments are legitimate.
As a small business owner in the construction industry, it's important to carefully weigh the pros and cons of taking a dividend instead of a salary. While dividends can offer tax advantages and flexibility, there are potential downsides, such as limited access to employment benefits and retirement savings options. Ultimately, the best choice for you will depend on your personal financial situation and your business's needs. Consult with a financial advisor or tax professional to determine the most advantageous payment method for your specific circumstances.