Incorporation vs Sole Proprietor

Quick Comparison

Tax Rate Comparison

Corporate Tax Rates (2024)

• Small business rate: ~12% (varies by province)
• Applies to first $500,000 of active business income
• Must be CCPC (Canadian-Controlled Private Corporation)

Personal Tax Rates

• 15% to 33% federal
• Plus provincial (5-25%)
• Combined top rates: 50-54%

The Catch: Integration

• When you pay yourself, you pay personal tax
• System designed for similar total tax
• Benefit is deferral, not elimination

When Sole Proprietor Makes Sense

Good Fit If

• Net business income under $75,000
• Need all profits for personal use
• Low liability risk
• Simple business operations
• Just starting out
• Side business alongside employment

Advantages

• No separate tax return
• Business losses offset other income
• No annual legal fees
• Simpler bookkeeping
• No shareholder agreements needed

When to Incorporate

Good Fit If

• Net income over $100,000+
• Can leave $50,000+ in corporation annually
• Liability exposure concerns
• Multiple shareholders planned
• Want to build corporate investments
• Planning to sell business eventually

Tax Deferral Example

Business profit: $150,000, personal needs: $80,000

• Sole proprietor: Tax on $150,000 = ~$50,000
• Corporation: Pay salary $80,000 (tax ~$20,000), corporate tax on $70,000 at 12% = $8,400
• Savings/deferral: ~$20,000
• $61,600 stays in corporation growing

Liability Protection

What's Protected

• Personal assets from business debts
• Corporate liability stays with corporation
• Shareholders risk only their investment

What's NOT Protected

• Personal guarantees (bank loans)
• Director liability (taxes, wages, environmental)
• Professional negligence
• Personal wrongdoing

Paying Yourself

Salary

• Deductible expense for corporation
• Taxed as employment income
• Creates RRSP room
• CPP required (both portions)
• Predictable personal income

Dividends

• Not deductible for corporation
• Taxed at preferential rates (gross-up/credit)
• No CPP contributions
• No RRSP room created
• Flexible timing

Salary vs Dividend Decision

• Need RRSP room? Salary
• Want CPP pension? Salary
• Have RRSP room? May prefer dividends
• Many use combination approach

Costs of Incorporation

Initial Setup

• Incorporation: $500-$1,500
• Legal setup: $500-$2,000
• Minute book, shares: $200-$500
• Total: $1,000-$3,000+

Annual Ongoing

• Corporate tax return: $1,000-$2,500
• Annual filings: $50-$100
• Bookkeeping: more complex
• Legal (if needed): varies

Break-Even Analysis

Extra annual cost: ~$1,500-$2,500

Need enough tax savings to justify

Lifetime Capital Gains Exemption

Huge Benefit

• $1,016,836 exemption (2024)
• On sale of qualified small business shares
• Tax-free capital gain on business sale
• Each shareholder gets own exemption

Requirements

• CCPC (Canadian-Controlled Private Corporation)
• Active business assets test (90%)
• Holding period requirements
• Planning needed years in advance

Income Splitting

TOSI Rules (Tax on Split Income)

• Limits splitting income with family
• Applies top tax rate to split income
• Unless family members meaningfully contribute
• Or are over 25 with capital at risk

Legitimate Splitting

• Salary for actual work (any family member)
• Dividends to involved family members
• Pension income splitting (later)
• Complex rules—professional advice needed

Administrative Burden

Corporation Requirements

• Separate bank account (required)
• Corporate tax return (T2)
• Annual filings with government
• Corporate minutes and resolutions
• Shareholder agreements
• More complex bookkeeping

Sole Proprietor Requirements

• Report on personal return (T2125)
• Track income and expenses
• Simpler record keeping
• One tax return

Professional Corporations

Special Rules

• Doctors, lawyers, accountants, etc.
• Provincial professional corporation rules
• May have restrictions on shareholders
• Liability still personal for negligence

Benefits

• Tax deferral possible
• Income smoothing
• Retirement planning flexibility
• Check professional body rules

Making the Decision

Questions to Ask

1. How much profit can I leave in the corporation?
2. What are my liability concerns?
3. Do I plan to sell the business?
4. Can I afford the extra costs?
5. How complex is my business?

General Guidelines

• Under $75K profit: Usually stay sole proprietor
• $75K-$150K: Analyze carefully
• Over $150K: Often incorporate
• Liability risk: May incorporate regardless

Transitioning Later

Starting Sole Proprietor

• Can incorporate later
• Section 85 rollover available
• Defer taxes on transfer
• Common progression

When to Switch

• Business stabilized and profitable
• Can project leaving profits in corp
• Ready for additional complexity