Vartika Satija, CPA, CA
Is Incorporation Right for your Business?
Updated: Aug 10, 2019
Whether incorporation is right for your business depends on various factors. While the administrative, compliance responsibilities and costs are much higher under a corporate structure the benefits include liability mitigation of the owner, tax deferral strategies and estate planning.
From Tax Point of View, incorporating your business is only effective if your business has grown enough to be worthwhile. You don’t only have enough income to offset the costs but need to be prepared to leave enough of your business earnings in the corporation to benefit from Corporate Tax Deferral Strategies.
Therefore, from tax perspective, there is no magic number as to when to incorporate.
For instance, it probably doesn’t make sense for a small business with minimal operating risk and net income under $50k to incorporate as the business already incurs lower tax rate. As the business grows and so do the tax liabilities and operational risk, it may be a good time to discuss if it’s time for incorporation. Each business owner should consult with a lawyer and accountant to determine if the increased costs are offset by the benefits.
Corporate Tax Deferral Strategies
One of the most significant advantages of incorporating is the ability to take advantage of the tax deferral strategies. The income earned within corporation is taxed at two different levels – once at corporate level and again at personal level when the income is distributed either as salary or dividend to the shareholder. The taxable income earned within a corporation from operating business, if considered active business income (ABI) for tax purposes, is subject to general federal corporate rate (15%) and applicable provincial corporate tax rates.
Further, if your corporation is considered a Canadian Controlled Private Corporation (CCPC) throughout the year, your corporation may benefit from Small Business Deduction (SBD), which lowers the tax rate to 9% on the first $500,000 of active business income (ABI). All provinces and territories also provide an SBD and have a small business limit of $500,000, except for Manitoba which has a limit of $450,000.
While the combined corporate federal and provincial general rate and small business tax rates vary by province and territory, the corporate tax rate on business income is generally lower than your personal marginal tax rate.
After incorporation, you can defer personal taxation on after tax business income until it is withdrawn from the corporation in the hands of the shareholder. That being said, the greater the funds are left in the corporation, the greater the deferral advantage will be.
Considerations in making the decision to Incorporate?
Consider asking this question, do you need a substantial portion of your business income to meet your annual living expenses and meet your financial goals? If so, then incorporating your business may not be beneficial. Keep in mind that withdrawing company funds for personal expenses can result in tax consequences and may not be able to benefit from the tax deferral advantage that a corporation can offer.
Further, if your company is in the early stages and currently generating business losses, you might consider delaying incorporation. As a sole proprietor, it might be beneficial for you to use the business losses against your personal income from other sources and lower your personal taxes.
Determining how to structure your company is an important decision that may have a significant impact on your business going forward. Consult with a qualified tax and legal advisor to ensure that you have taken into account all of your considerations before deciding whether or not to incorporate.
This publication has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The publication cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact your advisor or accountant to discuss these matters in the context of your particular circumstances. Vartika Satija, CPA, CA do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it.