How To Save Taxes by Incorporating a Business in Canada

In this article, Toronto business lawyer, Antonio DiMinno of DiMinno Rizzi Lawyers, answers the question: “How can I save taxes by incorporating a business in Canada?” 

Incorporation offers significant advantages for your business, but this article will focus on favorable corporate income tax treatment.

One of the most substantial advantages is a reduced income tax rate on active business income. In Canada, personal income taxes can go as high as 54% for the highest earners. However, as an incorporated small business, you may only pay 12-15% in income tax, depending on your province.

This means instead of keeping just $46 for every $100 you earn, your business could retain $88. This extra corporate income can be reinvested to boost your business further. It’s like putting your business in the fast lane! 

Not a math whiz? No problem! Let’s dive deeper into How to save taxes by incorporating a business in Canada.

How Much Tax Do I Pay When Incorporated?

Clients often wonder, “How much tax do I pay when incorporated?” While your accountant is the best source for personalized advice, we can give you a rough estimate by looking at some numbers. 

Consider the case of Emily, who runs a beauty spa/salon in Mississauga. She’s contemplating the idea of incorporating the business. Currently, as a sole proprietor, Emily’s company generates around $200,000 in annual revenue. Her annual business expenses, covering products and salon supplies, tally up to about $25,000. As a single individual, she relies solely on the income from the beauty spa/salon. Her personal living expenses, including rent, food, transportation, and essentials, come to roughly $50,000 a year. 

Here is the breakdown comparing her 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

If Emily incorporates, she will have $24,291.00 more cash available in her company 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, Emily will be able to enjoy these savings each and every year afterwards!

Clearly, incorporating can lead to significant tax savings, and you reap these benefits annually after a single incorporation expense. 

Incorporation also opens doors to other tax advantages like a lifetime capital gains deduction, income splitting with family members in the business, and using insurance and reorganizations for more tax savings. We delve into these additional benefits in our articles, Tax Benefits of Incorporating in Canada and “What Are the Advantages of Incorporating a Business in Canada?“. 

The business lawyers at DiMinno Rizzi have helped businesses like Emily’s incorporate and save substantial amounts on taxes over time. 

Will I Pay Less Tax if I Incorporate?

Once you’ve figured out that incorporating your business could be a tax-saving move, the next question you should ask is, “Will I really pay less tax if I incorporate?” In other words, while incorporation might save taxes for some entrepreneurs, will it do the same for you based on your unique financial situation? 

In our experience, most of our clients end up paying less in taxes after they’ve incorporated. This includes those making less than $50,000.00 in active business income.  

However, it’s essential to emphasize that incorporation may not always guarantee lower taxes. 

Here’s the deal: When you operate as a corporation, you’ll face a corporate tax rate of 12%. But here’s the catch—if you decide to take out the income left after corporate taxes as a salary, you’ll also have to pay personal income tax on that salary. 

Let’s take an example. One of our clients runs a landscaping business, let’s call it “Green Haven,” in Kingston, Ontario. The landscaping business currently operates as a sole proprietorship, pulling in an annual revenue of $150,000. Its yearly business expenses, covering equipment, maintenance, and marketing, sum up to around $40,000. As an individual, our client relies completely on the income his landscaping business generates to cover his personal expenses, which come to about $30,000 per year. 

Now, if he opts to incorporate “Green Haven,” he will be dealing with a corporate tax rate of 12% on the landscaping company’s profits. However, when he withdraws that income from the corporation as a salary, he’ll also be on the hook for personal income tax on that salary.  For this reason, we advised him that incorporation won’t save him too much in taxes at the moment.

So, while incorporation can potentially bring you tax benefits and savings, it’s crucial to remember that taxes will still be a consideration at both the corporate and personal levels. 

To learn more, check out our article: “Will I Pay Less Tax If I Incorporate?”

At What Active Business Income Level Should I Incorporate?

One question we often hear from our clients is, “At What Income Should I Incorporate in Canada?” There’s no one-size-fits-all answer to this query. The decision depends on your company’s profits, your applicable personal tax rate, and how much you need to withdraw as a salary to cover your personal expenses.

In our perspective, the key factor isn’t just how much your business earns; it’s about what remains after corporate taxes and how much you must take out as a salary. The more you can leave within the corporation, the more you can save on taxes. 

A key consideration is timing: you can choose when to pay personal tax by controlling how and when you withdraw money from your corporation. This flexibility in tax planning isn’t available to sole proprietors.

Let’s examine two examples: 

Example 1: Mario ‘s Home Renovation Company

Mario, a client of DiMinno Rizzi Lawyers, owns a home renovation company in London, Ontario. He earns $80,000 in profit from his business. After having to pay tax at the 12% corporate rate on profits ($9,600), his after tax income allows him to withdraw $20,000 from the corporation to cover his living expenses. Mario pays about $1,200 in personal taxes, including CPP/EI premiums, totaling $10,800. After all taxes, he has approximately $49,600 left in the business for reinvestment or withdrawal, resulting in tax savings of $8,200 for the year compared to not incorporating.

Example 2: Chad the Personal Trainer

Chad, an entrepreneur in Toronto, generates $200,000 in profit through his personal training business. Unfortunately, Chad spends all his earnings acquiring personal assets and maintaining a lavish lifestyle, including an expensive apartment, fine dining, and designer clothing. He withdraws the entire $176,000 profit as a salary, incurring $60,000 in personal income tax, totaling around $84,000 in taxes. 

Under current personal income tax rates, without incorporating, Chad would have paid about $71,000 in taxes. So, after incorporating, he ends up paying $13,000 MORE in taxes annually, along with ongoing incorporation costs of $3,000 per year. In Chad’s case, incorporating doesn’t work in his favor.

As you can see, there’s no specific income threshold for deciding when to incorporate. It all hinges on how much money you take out as a salary. Your lawyer and accountant can assist in determining if incorporation aligns with your financial goals. 

To learn more about using incorporation to save on taxes, check out our articles, “At What Income Should I Incorporate in Canada?”

How a Toronto Incorporation Lawyer Can Help

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

A good incorporation lawyer will work closely with your accountant to help clear the fog and ensure that your company is sailing in the right direction! 

Frequently Asked Questions

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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