Incorporation: Small Business Tax Guide

Corporate Tax Rates

Small Business Deduction (SBD)

For Canadian-controlled private corporations (CCPCs):

• Federal rate: 9% on first $500,000 of active business income
• Provincial rates: Vary from 0% (Manitoba) to 4% (PEI)
• Combined rate: Approximately 9-12% depending on province

General Corporate Rate

Income above $500,000 or passive income:

• Federal: 15%
• Combined: 23-31% depending on province

Investment Income

• High rate: ~50% on passive investment income
• Refundable portion when dividends paid out
• Complex rules—doesn't benefit from SBD

When Incorporation Makes Sense

Good Candidates

• High income: Earning more than you spend personally
• Can defer income: Don't need all earnings for living
• Business risk: Want liability protection
• Income splitting: Family members can be shareholders
• Selling business: Lifetime capital gains exemption

Poor Candidates

• Need all income: Personal expenses equal business income
• Low income: Already in low tax bracket
• Simple situation: Admin costs outweigh benefits
• Personal services business: Doesn't qualify for SBD

Salary vs. Dividends

Salary (T4 Income)

Advantages:

• Creates RRSP contribution room
• Contributes to CPP (pension benefits)
• Deductible to corporation
• Childcare expense deduction eligibility

Disadvantages:

• Payroll taxes (employer CPP portion)
• Requires payroll administration
• Higher personal tax rate

Dividends

Advantages:

• No payroll taxes
• Flexible timing
• Simpler administration
• Tax credit system (gross-up and dividend tax credit)

Disadvantages:

• No RRSP room created
• No CPP contributions
• Not deductible to corporation

Optimal Mix

Most owner-managers use a combination:

• Salary to max out RRSP room (~$175,000 for full room)
• Dividends for additional income needs
• Leave excess in corporation for tax deferral

Integration Concept

The Canadian tax system aims for "integration"—total tax should be similar whether you:

• Earn income personally, OR
• Earn through corporation and pay yourself

In practice, integration is imperfect, creating planning opportunities.

Lifetime Capital Gains Exemption (LCGE)

When selling qualified small business corporation (QSBC) shares:

• 2024 exemption: ~$1,016,836 per shareholder
• Multiple family shareholders can each use their exemption
• Requires meeting "all or substantially all" asset tests
• 24-month holding period before sale

Qualifying Criteria

• CCPC at time of sale
• 90%+ of assets used in active business (at sale)
• 50%+ test during 24 months before sale
• Shares held for at least 24 months

Income Splitting Opportunities

Family Shareholders

• Spouse and adult children can hold shares
• Pay dividends to shareholders in lower brackets
• Each uses their LCGE on sale

Tax on Split Income (TOSI)

Significant restrictions since 2018:

• Dividends to minors taxed at top rate
• Adults must meet "excluded" tests
• Must work 20+ hours/week in business, OR
• Own 10%+ of shares and business pays <90% to related
• Complex rules—professional advice essential

Costs of Incorporation

Setup Costs

• Legal fees: $1,000-$3,000
• Provincial registration: $200-$400
• Corporate minute book: $200-$500

Ongoing Costs

• Corporate tax return: $1,500-$5,000+/year
• Annual return filings: $50-$100
• Bookkeeping: $200-$500/month
• Payroll (if salary): Additional costs

Personal Services Business (PSB)

A corporation may be a PSB if:

• Would be employee if not for corporation
• Fewer than 5 full-time employees
• Main client controls work performed

PSB Consequences

• No small business deduction
• Limited expense deductions
• Tax rate ~44% (no benefit vs. personal)
• Common issue for IT contractors

Professional Corporations

Doctors, lawyers, accountants, dentists can incorporate:

• Same SBD benefits
• Provincial rules vary on who can be shareholders
• Many provinces restrict family ownership
• Still provides tax deferral on retained earnings

Corporate Year-End Planning

Choosing Year-End

• Can be any date, not just December 31
• Consider timing of income and expenses
• Allows bonus accrual planning
• Coordinate with personal tax situation

Bonus Accrual

• Declare bonus by corporate year-end
• Must pay within 180 days
• Deductible to corp in year declared
• Taxable to you when received

Investment Holding in Corporation

Passive Investment Income

• Taxed at ~50% in corporation
• Refundable when dividends paid
• SBD grind: Passive income over $50K reduces SBD

SBD Grind

• Every $1 of passive income over $50,000 reduces SBD room by $5
• $150,000 passive income = no SBD
• Consider corporate class funds or holding companies

Common Mistakes

• Incorporating too early: Before income justifies costs
• Not paying reasonable salary: RRSP room lost forever
• PSB rules: Not structuring to avoid PSB status
• Mixing personal and business: Creates taxable benefits
• Ignoring integration: Thinking corporate rate is final rate

Steps to Incorporate

1. Consult accountant to confirm benefits
2. Choose federal vs. provincial incorporation
3. Select corporation name (or numbered)
4. Prepare articles of incorporation
5. Create shareholders' agreement (if multiple)
6. Set up corporate bank account
7. Register for GST/HST if required
8. Transfer assets to corporation
9. Set up payroll (if paying salary)