Tax Benefits of Incorporating Your Business: Is It the Right Move?

As a small business owner, you may have wondered whether incorporating your business is the right move for you. While incorporating can seem like a significant decision with many considerations, it can offer numerous tax benefits that may help you grow your business and reduce your overall tax burden.

In this blog, we’ll dive into the key tax advantages of incorporating your business and explain how these benefits can help you achieve both short-term and long-term financial success.

1. Lower Corporate Tax Rates

One of the main reasons small business owners choose to incorporate is the lower tax rate on corporate income. In Canada, corporations are taxed separately from their owners. Corporate tax rates are generally lower than personal income tax rates, which means that incorporating your business can help you retain more of your earnings.

• For Canadian-Controlled Private Corporations (CCPCs), the first $500,000 of active business income may be eligible for the Small Business Deduction (SBD), which reduces the corporate tax rate to as low as 9%.

• After the $500,000 threshold, corporate income will be taxed at the general corporate tax rate, but it’s still typically lower than the highest personal tax rates.

By incorporating, you’re able to take advantage of these lower tax rates, allowing you to keep more of your business’s profits within the corporation for reinvestment or other purposes.

Tip: If you’re operating as a sole proprietorship or partnership, consider incorporating to take advantage of these lower corporate tax rates, especially if your business is generating significant profits.

2. Tax Deferral Opportunities

Incorporating your business also opens up the possibility of tax deferral. When you operate a corporation, you can choose to leave profits inside the business instead of taking them as personal income. This deferral allows you to reduce your current personal tax liability.

• For example, if you pay yourself a salary or dividends from your corporation, you’ll be taxed personally on that income in the year you receive it. However, if you leave the profits within the corporation, you won’t pay personal taxes on those funds until you withdraw them.

• This gives you the opportunity to defer personal taxes to a later year, which can be beneficial if you anticipate being in a lower tax bracket in the future.

This flexibility allows you to manage your tax situation more effectively and make smarter financial decisions for your business.

Tip: The ability to defer taxes is a powerful strategy for long-term tax planning. Work with your accountant to determine the best approach for managing your business’s income and tax liability.

3. Income Splitting with Family Members

Incorporating your business can provide opportunities for income splitting with family members, which can lower the overall family tax burden. If your family members are shareholders of your corporation, you may be able to distribute dividends to them, especially if they’re in a lower tax bracket than you.

• Dividends paid to family members are subject to personal tax rates, but the lower the income of the recipient, the lower their tax liability. This can be an effective way to spread income among family members and reduce the overall tax burden on the family unit.

However, be aware that Tax on Split Income (TOSI) rules limit income splitting in certain situations, particularly if the family member is not actively involved in the business. These rules are complex, so it’s crucial to consult with a tax professional before implementing any income splitting strategy.

Tip: Speak with your tax advisor to ensure you’re maximizing the benefits of income splitting without triggering any penalties or compliance issues related to TOSI.

4. Access to Corporate Tax Credits and Incentives

Corporations are eligible for various tax credits and incentives that aren’t available to sole proprietors or partnerships. For example:

• Scientific Research and Experimental Development (SR&ED) Tax Credit: If your business is involved in research and development, you may be eligible for the SR&ED tax credit, which can offset some of your R&D expenses.

• Investment Tax Credits (ITC): Your corporation may be eligible for tax credits if it invests in certain assets, such as equipment, machinery, or environmentally friendly technologies.

Additionally, corporations may qualify for provincial or federal grants, funding programs, and other incentives that can reduce operating costs or fund specific business initiatives.

Tip: Keep track of any research, innovation, or investments your business makes, as they could potentially qualify for tax credits or other incentives. Consult your accountant for guidance on available programs.

5. Enhanced Credibility and Legal Protection

While not directly related to taxes, incorporating your business provides legal protection through limited liability. As a corporation, your personal assets are generally protected from business debts or liabilities. This can provide peace of mind as you grow your business.

Furthermore, incorporation can enhance your business’s credibility with clients, suppliers, and investors. Being a registered corporation shows that your business is established, formal, and potentially more stable than a sole proprietorship or partnership.

Tip: While incorporating provides legal and business advantages, it’s important to consider the associated costs and administrative requirements. Consult with a lawyer or business advisor to ensure that incorporation aligns with your business goals.

6. Ability to Build a Corporate Pension Plan

Corporations have the ability to set up Individual Pension Plans (IPP) or other retirement savings plans for their employees (including themselves as business owners). These plans allow for larger annual contribution limits compared to an RRSP, making it easier to build retirement savings.

• IPP contributions are considered a business expense, reducing the corporation’s taxable income.

• If you have employees, setting up a pension plan can also help attract and retain top talent.

Tip: If you’re looking to save for retirement in a more structured way, setting up an IPP through your corporation can offer significant benefits. Consult your financial advisor to explore this option.

Conclusion: Is Incorporating Right for Your Business?

Incorporating your business offers significant tax advantages, such as lower corporate tax rates, tax deferral opportunities, and access to various credits and incentives. It can also provide legal protection and enhance your business’s credibility. However, the decision to incorporate should be made after considering your business’s unique needs, goals, and financial situation.

If you’re unsure whether incorporating is the best option for your business or need assistance with the incorporation process, our team of tax professionals is here to guide you through every step. Reach out to us today to discuss how incorporating can benefit your business and optimize your tax strategy.