On average, over 90,000 new businesses are created every year in Canada. Many of those are owned by a sole proprietor or a partnership. 

However, many businesses could incorporate and enjoy a variety of benefits that business incorporation brings, including considerable tax advantages. In fact, for certain businesses, the tax benefits of incorporating are so appealing that tens of thousands of them become corporations every year. 

Tax preparation season is a good time to take a look at your unincorporated business and consider whether you should consider changing its status. If you don’t need all of your business’s income for your personal needs, it could make sense to incorporate it. 

In this article, we examine the different kinds of business ownership, the types of tax advantages and savings that can come with incorporation, and whether it might be a valid option for your business. 

The three types of small business ownership 

A common type of small business owner is the sole proprietor. The business has just one owner and, as far as Canada Revenue is concerned, there is no distinction between the business and the owner. 

Profits are taxed at your personal income tax rate, which will vary depending on your taxable income and the province you live in. Any losses can be used to reduce your taxable income (which will probably reduce your tax owed and could bring you into a lower tax bracket). 

A partnership is a business that’s owned by two or more people (with all partners typically sharing the profits — and the losses). It’s similar to a sole proprietorship in that a partnership business does not file a separate tax return. Each partner would report their share of the partnership’s income on their own personal tax return. 

Sole proprietors and partners are personally responsible for any debts their business might have — if your company reneges on a debt, your lenders could seek payment through your personal assets, which could include your savings, investments and even your home. 

When you incorporate your business, your company effectively becomes a legal entity in its own right, which can provide considerable personal protection from creditors. There are also several tax benefits of incorporating that don’t apply to proprietorships or partnerships. 

The tax benefits of incorporating 

The four key tax benefits of incorporating can save you thousands of dollars every year and considerably more if you plan to sell your business further down the line. None of the following tax benefits are available to unincorporated businesses. 

Corporate tax rates are lower than personal income tax rates 

Incorporated small businesses can pay very low income tax. The small business deduction reduces a company’s federal corporate tax to 9% (on up to $500,000 of active business income), while provincial corporate tax ranges between 0%-3.2%, depending on your province. The combined tax rate would therefore be between 9 to 12.2% for eligible Canadian-controlled private corporations. 

Compare this to your personal income tax rate, which could be 50% or more, depending on where you live and your level of taxable income. 

The ability to defer personal income tax 

If, for your personal income, you need less money than your company makes in profits, another of the tax benefits of incorporating is that you only have to declare the money you withdraw from the company on your tax return (which would usually be in the form of a salary or dividends). 

By leaving the remaining profit in your corporation, you can defer paying personal income tax on it until the time you need it for personal use. Retained profits can be used to expand the business, invest more passively for future retirement or other uses, or fund life insurance strategies that can deliver tax advantages. 

Incorporating allows you to keep more money in your company and use it to build up your wealth, effectively deferring paying tax until you need to withdraw the money for your personal use.  

Income splitting 

You can make your spouse a shareholder and then wait until you turn 65 before paying them a dividend. Also, if your spouse works in the business on average 20 or more hours per week in the current year, or has done so in any five prior years, there is no limitation on the amount of dividends you can pay them if they’re a shareholder. For seasonal businesses, the 20 hours per week rule only applies during the portion of the year in which the business operates. This can help you to share the business’s retained profits with your spouse and potentially move you into a lower tax bracket, so you end up paying less tax. 

Your spouse would then pay tax at their personal income tax bracket, which, if lower than your own, could lead to considerable tax savings.  

Save on tax when you sell your business 

There is a lifetime capital gains exemption for incorporated businesses when you sell the shares of a qualifying small business corporation. There are a number of conditions to satisfy in order to claim the exemption, but the tax savings available are substantial. For 2022, the exemption was $913,630. 

This could mean that you would pay much less or even zero taxes on the profits from the sale. Let’s say you sold shares in your business in 2022 for $1 million profit. You would only have paid tax on the difference between your profit and the exemption, so: 

$1 million – $913,630 = $86,370 

Therefore, only half of that amount — $43,185 — would be considered taxable income. This option is not available to unincorporated businesses, because they cannot issue shares. 

This can be a big benefit of incorporating and is often a key reason for entrepreneurs to incorporate their business. Another advantage is that the lifetime capital gains exemption can be used more than once, until you reach the limit. 

Is incorporating your business right for you? 

Incorporating a business won’t be the right decision for every entrepreneur. There are several factors you’ll need to consider first, such as how much profit your company makes, the type of business you own and your own personal tax situation. 

There are costs involved in incorporating, both for setting it up and on an ongoing basis, plus added administration to manage, so it’s important to weigh these up against the potential financial benefits. 

Your IG Advisor can help you to work out if business incorporation is a good idea for you. They can discuss your business’s situation and your personal income with IG’s team of tax experts, to help you understand if business incorporation will be beneficial for you. 

Contact your IG Advisor today to arrange a meeting to see if the tax benefits of incorporating will work for your business.  

Written and published by IG Wealth Management as a general source of information only. Not intended as a solicitation to buy or sell specific investments, or to provide tax, legal or investment advice. Seek advice on your specific circumstances from an IG Wealth Management Consultant. 

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