How Much Tax do I Pay When Incorporated?

Understanding How Corporate Tax Really Works

Here’s something exciting about incorporating your business in Canada – you get access to a powerful two-tiered tax system that can really work in your favor! Unlike unincorporated businesses that pay straight personal tax rates, corporations enjoy some significant tax breaks. Let me break this down in a way that’s easy to understand.

The Basic Tax Structure

These rates are set and administered by the Canada Revenue Agency (CRA) at the federal level, working in conjunction with provincial tax authorities. Think of corporate tax like a layer cake – you’ve got your federal layer and your provincial layer. Here’s how the federal portion works:

Component	Rate
Basic Federal Rate	38%
Federal Abatement	-10%
General Rate Reduction	-13%
Net Federal Rate	15%

Don’t let that 38% basic rate scare you! After the abatement and reductions, you’re looking at just 15% for general income. Even better – if you’re running a Canadian-controlled private corporation (that’s most small businesses), you’ll pay just 9% on your first $500,000 of active business income. Now that’s a deal!

Small Business Sweet Spot

Here’s where it gets really good for small business owners. Your Canadian-controlled private corporation gets some amazing perks. That sweet 9% federal corporate tax rate on your first $500,000 of active business income we mentioned. Extra provincial tax breaks that can drop your rate even lower – we’re talking as low as 0% to 3.2% depending on your province

Just keep in mind that these great rates start to phase out if your corporation earns more than $50,000 in passive investment income (think interest, dividends, or rental income), and they’re gone completely at $150,000. But hey, that’s still a lot of room to work with!

Investment Income & Capital Gains

Now, if your corporation is making investment income, the rules are a bit different. You’re looking at a 38% combined federal rate, which includes a 28% base rate plus 10% refundable federal tax.

And here’s some fresh news about capital gains – as of June 25, 2024, there are some important changes:

• If you make capital gains over $250,000, you’ll now include two-thirds of those gains instead of just half
• The lifetime capital gains exemption has been bumped up to $1,250,000
• There’s an exciting new program called the Canadian Entrepreneurs’ Incentive for business owners who qualify

The best part? If you can keep some profits in your corporation instead of taking them all out as personal income, these tax advantages can really add up. It’s like having a tax-efficient savings account for your business!

Now, let’s look at how you can put these tax savings to work for your business…

How Can I Save Taxes By Incorporating In Canada?

One of the first questions many of our clients ask is “How can I save taxes by incorporating in Canada?” While tax advantages and corporate tax rates are important considerations, this is ultimately a question best answered by your accountant. However, we can get a rough idea of whether incorporation and becoming a separate legal entity is beneficial by looking at the numbers.

Let’s look at an example from one of our clients to better understand how incorporating affects your taxable income.

Alex runs a commercial cleaning company in Mississauga and is contemplating the idea of changing from an unincorporated business to a separate legal entity through incorporation. As a sole proprietor, his business generates active business income of approximately $200,000 annually. Alex incurs about $25,000 in yearly business expenses, which cover items such as advertising costs and cleaning supplies. As an individual taxpayer, Alex relies exclusively on the business income earned from the commercial cleaning business. Personal living expenses, including rent, food, transportation, and other essentials, amount to about $50,000 per year.

Here is the breakdown comparing his two options:

SOLE PROPRIETOR		CORPORATION
PERSONAL INCOME		CORPORATE INCOME
Annual Income from Self Employment	$200,000	Annual PREC Income	$200,000
Operating Expenses	-$25,000	Operating Expenses	-$25,000
Taxable Personal Income	$175,000	Taxable PREC Income	$175,000
Personal Tax Payable on Taxable Income (Marginal Rate 49.29%)	-$57,166	Corporate Tax Payable on Gross Income (Marginal Rate 12.5%)	-$21,875
Net Income	$117,834	Net PREC Income	$153,125
Living Expenses	-$50,000	Living Expenses	-$50,000
		Personal Income Tax Paid to Withdraw from PREC	-$11,000
After-Tax Cash Available for Investment	$67,834	After-Tax Corporate Cash Available for Investment	$92,125
			+$24,291.00

The examples provided above are generic in nature and tax rates are approximate as of the writing of this guide. Tax results will vary widely based on individual circumstances. Obtain professional tax advice prior to incorporating.

If Alex incorporates, his corporation’s income will have $24,291.00 more available to reinvest, or withdraw in a lower income tax year. The savings of $24,291.00 in the first year of having a corporation pays for the initial incorporation fee ten times over! Even better, Alex will be able to enjoy these corporate tax savings each and every year afterwards!

As you can see, you can save considerable taxes when you incorporate. What’s more is that you get the tax benefits year after year, while only having to pay to incorporate once!

In addition to saving on income tax, incorporating can give you a lifetime capital gains deduction, income splitting opportunities with family members in the business, and tax planning strategies through insurance and reorganizations. We discuss these additional tax benefits in more detail in our article “What are the tax benefits of incorporating my business” (to be written)

At DiMinno Rizzi Lawyers, we’ve helped businesses just like Alex’s incorporate and save hundreds of thousands in tax over time. 

Will I Pay Less Tax If I Incorporate?

After determining that incorporation can save you a lot of taxes, the next question to ask is: “ Will I pay less tax if I incorporate?”. In other words, incorporating may save other entrepreneurs tax, but will it save ME tax, given my specific financials.

In our experience, most of our clients end up paying less in combined corporate income tax and personal income tax after they have incorporated. Even our clients making less than $50,000.00 in active business income have benefited from incorporation.

However, we need to stress this point: incorporating may not mean you pay less tax in all cases.

It’s important to understand that operating as a private corporation means paying corporate tax rates – currently 12.2% in Ontario (combined federal and provincial rates). However, if you decide to withdraw the income left after corporate taxes as either salary or dividends, you’ll face personal income tax rates on those withdrawals.

Imagine you run a bakery called “Sweet Delights” in Caledon, Ontario. Your bakery operates as a sole proprietorship, and it generates an annual revenue of $150,000. Your yearly business expenses, including ingredients, rent, and marketing, total approximately $40,000. As a single person, you rely entirely on the business income earned from your bakery to cover your personal expenses, which amount to around $30,000 per year.

Now, if you incorporate “Sweet Delights,” your corporation’s taxable income would face that lower corporate tax rate of 12.2%. The twist? Taking money out as either salary or dividends means you’ll still need to file a personal tax return and pay personal income tax on those amounts.

So, while incorporation can offer potential tax benefits and savings, there will still be taxes to consider at both the corporate and personal levels.

At What Income Level Should I Incorporate?

Another common question our clients ask is “at what income level should I incorporate”?

There’s no one-size-fits-all answer for this question. The answer depends on several factors: your business income, corporate tax rates, and how much money you need to withdraw as personal income to cover your expenses.

In our view, it is not so much how much your business makes that is the crucial factor. The most important question is, “after my corporate income is taxed at the corporate rate, how much of the remainder do I need to withdraw as a salary?” The more money you can afford to leave in the corporation, the more you’ll benefit from lower tax rates!

Let’s compare two examples.

Example 1: George’s Accounting Company

George is a client of DiMinno Rizzi Lawyers. As a young entrepreneur, his small business generates $70,000 in taxable income through his Ottawa-based accounting corporation. As other Canadian controlled private corporations, George pays the lower rate of 12% on the $70,000, amounting to $8,400 in corporate taxes. Living frugally with roommates, his total living expenses are just $15,000 per year, which he withdraws from the corporation as salary. George pays personal income tax of about $1,000 on the $15,000, including CPP/EI premiums of $900. His total tax burden is approximately $9,400.

After all corporate income taxes and personal income taxes, George retains about $47,000 in the business to either reinvest or withdraw during a year with lower tax rates.

Had DiMinno Rizzi Lawyers not incorporated George, George would have paid $17,100 in taxes. That’s $7700 in tax savings in one year!

Example 2: Michael’s Marketing Company

Michael is a marketing agency owner in Toronto. His marketing agency makes $200,000.00 in taxable income. Unfortunately, Michael spends all of his corporate income on his living expenses, which include an expensive downtown apartment, dining at fancy restaurants, and wearing designer clothing.

So, Michael’s business pays the lower rate of corporate tax (12%) on the $200,000 profit, leaving $176,000 in the corporation. But, he needs to cover his lavish lifestyle, so he withdraws all of the $176,000 as a salary. He pays another $60,000 in personal income tax on the $176,000 salary. Combined with his corporate taxes, Michael’s total tax burden reaches $84,000.

Had he not incorporated, Michael would have paid a total of about $71,000 in taxes. So, after incorporating, Michael is paying $13,000 MORE in taxes this year, plus ongoing incorporation costs of $3,000 per year. Michael would have been better off without a corporation!

As you can see, there’s no universal income level where incorporation automatically makes sense. The tax advantages depend largely on how much income you need to withdraw from the corporation. Your lawyer and accountant can help analyze whether the corporate tax rates and small business deduction would benefit your situation.

How a Ontario Incorporation Lawyer Can Help

When considering incorporation, a crucial first step is to speak to an incorporation lawyer.

At DiMinno Rizzi Lawyers, we offer free consultations to learn about your business and discuss whether incorporation is the best decision for you. We’ll help you navigate the provincial and territorial rates and ensure your business structure optimizes your tax position!

Disclaimer: All number figures are approximate only and may be subject to change. Like all material on this website, this is not financial, legal, or tax advice. Contact a professional for your specific situation. 

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