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By Jillian Koch - JMH & Co

PRO Tips by Jillian Koch

To Incorporate or Not to Incorporate

Nov 22, 2021 | 9:58 AM

We hear about it often in the media – large corporations who are paying absolutely nothing in corporate taxes. While we aren’t going to go down the rabbit hole that is Amazon and Google (or other large corporations), we are going to try to demystify the average corporation here in Canada and look at just how that “big bad” corporations are being taxed.

To help illustrate this, let’s take a look at a fictitious example. Inspired by last month’s article about starting a business, John quit his job and started his own company, John’s Building Corporation.

The Tax Rate is How Much?

John’s Building Corporation is a Canadian controlled company that has taxable income of $200,000. In Alberta, this means that the company $22,000 in tax ($19,000 to the Federal government and $4,000 to the Alberta government) for a combined tax rate of 11%.

That seems like a great deal to John. When he was an employee earning the same amount of money, he paid a little over $63,000 in tax on the same $200,000 of income. At the end of the day, over 31.50% of his income went to taxes! To keep it simple, this ignores any CPP or EI requirements.

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Getting Money Out of the Company

Before John puts a deposit down on his yacht – he needs to take those low taxed-dollars out of the company. After paying his taxes, he has $178,000 sitting in the corporate bank account. These low-taxed funds can pose a tax-problem when the funds are needed by John personally.

This problem is that John hasn’t made any money personally – only the corporation has. This means that John now needs to pay himself a wage or a dividend to get that money into his personal hands. If he took that full amount as a dividend, John will personally be paying $42,500 in taxes.

After he receives the funds, he will have paid $64,500 in taxes at both the corporate and personal level.

Why Would John Ever Choose to Have a Corporation?

The Canadian income tax system is built on the premise that regardless of how the money gets to the individual, it will have the same amount of tax paid on it by the time it reaches them (otherwise, everyone would have a corporation to pay less tax). It’s not a flawless system so there is sometimes some tax leakage or tax savings depending on how the money flows down to the shareholder.

The true benefits of a corporation are in tax deferral opportunities, which can be used to grow wealth within the corporation.

The Corporate Advantage: Earn Now and Pay Later

We can clearly see that John’s Building Corporation is paying substantially less in taxes on the money it earns. Essentially, 89% of its income is reinvested into the company compared to the 69.5% John would have access to without the corporation. Therein lies the benefit of a corporation – utilizing low taxed funds within the company to grow the business and build wealth.

In the future, John’s Building Corporation will wind up and pay out all of its excess cash – causing personal taxes payable by John. Until that occurs, John can use those funds to continue to expand his business, and accumulate wealth.

Taxes Aren’t the Only Benefit

Deferring taxes aren’t the only reason for incorporating. Creditor protection (protecting personal assets from claims if the company goes bankrupt), improved access to financing and the potential for splitting income are just some of the considerations behind a decision to incorporate.

Not all people who are operating business need to incorporate but sometimes the ability to defer that tax until you absolutely need the cash flow can help your business expand more rapidly. If you are like John and want to start your own business, make sure you speak with a business advisor to find out if incorporation is the right step for you.