Incorporating your business is one of the biggest financial decisions you’ll make as an entrepreneur in Canada. While incorporation has many benefits, such as limited liability and more credibility, it changes how your business is taxed. Get professional advice from a tax accountant Burnaby to understand these changes so you can comply with CRA and make informed decisions.
From Personal to Corporate Taxation
When you’re a sole proprietor or partnership, business income is reported on your personal tax return. This means profits are taxed at your personal marginal tax rate, which can be very high depending on your income. Once incorporated, the business becomes a separate entity. The corporation files its own T2 corporate tax return and pays tax at corporate rates which are generally lower than top personal tax rates.
This separation gives you tax planning opportunities. Instead of having all income taxed personally, you can leave profits in the corporation to be taxed at lower corporate rates and defer personal tax until funds are withdrawn as dividends or salary.
Access to the Small Business Deduction
One of the biggest tax benefits of incorporation is the Small Business Deduction (SBD). Canadian-controlled private corporations (CCPCs) can qualify for a lower corporate tax rate on the first $500,000 of active business income. This rate is much lower than personal rates, so incorporation is especially attractive for growing businesses that retain earnings rather than distribute them all to shareholders.
But access to the SBD comes with conditions. For example, passive investment income earned in the corporation can reduce the deduction. And if multiple corporations are associated, the limit must be shared between them. It’s important to work with an accounting firm that provides reliable tax services London Ontario to ensure Small Business Deduction is fully claimed.
More Filing and Compliance Requirements
Incorporation also brings more responsibilities. A corporation must file a T2 return every year, regardless of income. Beyond tax returns, corporations may need to prepare financial statements, remit GST/HST and file T4 or T5 slips if paying salaries or dividends. This added complexity often requires the help of a tax accountant.
And directors of the corporation must ensure CRA compliance. Penalties for late or inaccurate filings can be severe and unlike sole proprietorships, corporate reporting obligations are ongoing even in years with little or no activity.
Flexibility in Income Splitting and Compensation
Another benefit of incorporation is flexibility in how business owners can pay themselves. As an individual, all profits flow directly as personal income. With a corporation, owners can structure compensation through a mix of salary, dividends or both.
- Salaryis deductible for the corporation and provides RRSP contribution room for the shareholder.
- Dividendsare not deductible to the corporation but may be taxed at a lower personal rate due to dividend tax credits.
- Income splittingwith family members may be possible through share ownership or employment though the recent tax on split income (TOSI) rules have limited this opportunity.
Deferral and Investment Opportunities
By leaving profits in the corporation after paying corporate tax, you can defer personal tax. These retained earnings can be reinvested in the business, used to purchase assets or invested in a corporate investment portfolio. Over time, this tax deferral can accelerate growth and wealth accumulation.
But be mindful of passive investment income in the corporation, as it can reduce access to the Small Business Deduction and increase overall tax.
Payroll and Other Obligations
Incorporated businesses that pay salaries must register for a payroll account with the CRA, withhold source deductions (CPP, EI and income tax) and remit them monthly or quarterly. This adds another layer of responsibility not faced by sole proprietors, who simply report net business income personally.
Failure to remit payroll deductions on time can result in severe penalties and personal liability for directors. So while incorporation gives you flexibility, it also brings new obligations that must be managed.
Professional Support is Required
With the benefits of incorporation come complexities. Determining whether incorporation is right for your business requires analysis of income levels, future growth and personal financial goals. For many small business owners, the decision is not just about saving taxes today, but about long-term planning, retirement and succession.
Working with a Chartered Professional Accountant (CPA) can help you navigate these issues. A CPA can advise on whether incorporation is beneficial, ensure your filings are CRA compliant and design a compensation strategy that maximizes your tax position.
Conclusion
Incorporating your business is a big change in how you are taxed. It gives you lower tax rates, tax deferral and compensation planning but also new compliance and administrative obligations. By knowing this and getting professional help, you can make incorporation work for you and not against you.
