The Benefits of Incorporating Your Business (Tax Implications)

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The information within these articles are derived from the sources listed at the end.

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There are many advantages and disadvantages to incorporating your business. This article will examine the tax side of things.

The Small Business Deduction

If you read the tax manual articles, you would have noticed that the small business deduction is a lower rate of tax that applies to the first $500,000 of your active business income. To compare, business owners at the top tax bracket who would usually pay 50% tax on their income would pay 13% tax on the first $500,000 if they incorporate. Keep in mind though, that this is just a tax deferral, not a tax saving, as there will be a second level of tax once you pay out after-tax profits as dividends or sell your shares in the business. The advantages of a tax deferral are that since you are not taxed as high on your income from the beginning, the increased cash flow can be reinvested back into your business or other investments which could result in greater returns. Another advantage of deferral would be the fact that increased cash flow in the earlier stages of your business due to the small business deduction could reduce the risk of failure, since it can provide additional resources or larger loans, since you have proof that you are more able to pay it back. Note, this advantage is at its best when the business is earning around the $500,000 range. Once you start reinvesting your increased cash flows to generate income over the $500,000 limit or generate property income, some double taxation will occur that may reduce the small business deduction benefit over time.

Other Advantages

Employment BenefitsAs a proprietorship, the owner cannot be considered an employee since the business is not separate from the ownerAs a corporation, the owner can get various employment benefits since the corporation is its own entityA lot of the benefits are fully deductible from the employer’s taxable income and not taxable to the employee, so it’s beneficial for both parties
FlexibilityCorporations allow for shares to be issued, so it would be easier to bring family members into ownership and change their percentage of ownership through issuing shares
Stable Annual IncomeWhen incorporated, there are two levels of taxationThe first level is when the corporation is taxedThe second level is when the after-tax profits are distributed to shareholders and they have to pay their own personal tax on incomeYou can choose whether to distribute the dividends to yourself and other shareholders, or just reinvest the profits back into the corporation, depending on the situation you’re in

Disadvantages

Use of LossesOnce incorporated, you can no longer use losses generated in the business against your own taxable income, since the business is now a separate entity
Compliance Requirements & CostsE.g. a corporate tax return needs to be filed with T4 and T5 slips that report salaries and dividends paid out of the corporationE.g. corporations have to maintain a minute book, which is a collection of all the important corporate records that should be accessible to shareholders and the corporation’s creditors

Resources

Buckwold, William, et al. Canadian Income Taxation, 2021/2022. McGraw-Hill Education, 2021.

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