Should I incorporate?

One question I hear frequently from new business owners is, “When should I incorporate my business?” There are many operational, regulatory, legal, and tax reasons why you might choose to incorporate. This post will try to clarify why it might be advantageous to incorporate from a tax perspective.

How does corporate income tax work?

If your corporation qualifies for the Small Business Deduction (SBD), the current federal income tax rate on corporations is 9% on the first $500,000 of taxable active business income. Provincial corporate tax rates are then added to this, which range from 0% (Manitoba) to 11.5% (Quebec). These rates are lower than the personal tax rates in even the lowest tax brackets and are considerably lower than the highest marginal tax rates, which approach 50% in many provinces.

For most people, this tax rate differential means that for every additional dollar of corporate income you draw from the business, you will save less corporate tax than you’ll incur as personal tax. So although the corporation is paying income tax on its profits, those profits are taxed at a significantly reduced rate compared to the rate it would subjected to if you were operating as a sole proprietor.

tl;dr The tax advantages of incorporation are only realized when the business generates more net income than the shareholders draw as personal compensation. Stated another way, corporate tax benefits only work when the corporation is paying income tax.