Generally speaking, you need to incorporate if you are running an active business and making at least $30,000 per year. A corporation allows you the flexibility to defer income, manage your personal tax brackets and limit legal liability where there are no personal guarantees.
There are other factors to consider during the growth period. If you find that you are reinvesting your profits in your business for things such as accounts receivable, inventory, equipment, property, then you must incorporate because the tax rate paid in a corporation is at 18%. Once you pass the $30,000 income base, you would pay personal taxes at 31% hence you would save at least 71% on your total tax bill
If you find you are not using all the profits for personal expenses, and you invest in rental properties to earn passive income and you have a family, you should consider a family trust. You can set up the trust in such a way that you would not pay personal income taxes and pass the dividends on a tax free basis to reinvest. Here is how a family trust works:
- The family trust would own the common shares of your corporation.
- Your corporation would pay 18% tax on its profit. The remaining 82% can be paid as a dividend to the family trust
- The family trust would designate one if its beneficiaries as another corporation that would pay no tax.
- You would reinvest 82% of the net income of the corporation.
- This would avoid you to pay personal taxes between 31%-44%.
- Now you have invested 82% instead of 69%-56% - more cash in your jeans to reinvest!
a family trust also helps you;
- in passing your assets to future generation without paying tax,
- helps you to split income with other members of your family(not minors),
- allows minor children to get capital gains income,
- allows you to multiply the $500,000 capital gains exemption.
- As a Shareholder of an active Canadian controlled small :
As a Shareholder of an active Canadian controlled small business Corporation, each individual is allowed to sell its shares under certain conditions and claim $500,000 in capital gains exemption. This is not available if you are a proprietor or you earn passive income.
The legal liability component kicks in when there are no personal guarantees. Banks generally do not loan monies to corporations without personal guarantees. The limited liability kicks in when you are dealing with suppliers. Typically, you should not provide personal guarantees to suppliers. You also should secure your shareholder's loans to the company. If the company goes under for reasons beyond your control, your monies will be secured after trust liabilities and secured creditors.
Here is a summary checklist for discussion on whether you should incorporate or not:
All Corporations
- Limited liability
- Tax deferral on bonuses
- Tax deferral in use of dividends
- Employee benefits
- Manage personal income
- Individual pension plans - interest deductibility on borrowings
- Ability to set family trusts
- Estate planning
- Probate fees
- Income splitting
- Employee benefits
- Foreign Taxes avoidance
- Foreign death duty avoidance
Additional reasons for Small Business CorporationTax Deferral
- Tax reduction in flow-through (nominal)
- Capital gains exemption
- Allowable business investment loss (ABIL) treatment
- Rate efficiency to finance assets acquisition
- Rate efficiency on Employee benefits
- Health care premiums
- Retiring allowance
- Memberships, etc
- Meal & Vehicle allowances
Disadvantages
- Incorporation cost
- Annual maintenance cost
- Complexity Sec51 (1)
- Personal use of losses
- Rate of flow through other than SBC indicates double tax
- Donations
- Winding up procedure
- Does not work with passive income