There are countless reasons and benefits of incorporating a business. They include limiting liability, estate planning and taking advantage of the lifetime capital gains exemption. One of the more enticing reasons for incorporation is the tax deferral benefits business owners obtain.
Corporate tax rates for small to mediums size enterprises (SME) tend to be much lower than personal tax rates. Consequently, incorporation offers business owners the opportunity to save and/or defer tax.
Consider the following example illustrating this opportunity:
John is a doctor who lives in Quebec. He earns $315,000 per year but only needs $215,000,000 before tax for personal use. If john is not incorporated, he will pay a tax rate of 53.31% on the remaining $100,000. This equates to a tax liability of $53,310. However, if John decided to incorporate and shelter the company's money, the remaining $100,000 would be subject to a tax rate of 26.5%. In this scenario, John's tax liability would be $26,500. Thus, the decision to incorporate his business would reduce his income tax by $26,810.
It should be highlighted that the above example considers federal and provincial income tax rates.
It is important to remember that the abovementioned amount of $26,810 is simply a tax deferral. This means that when John decides to issue this money from the company to himself by way of dividend or salary, he will have to pay personal income tax on it. Nevertheless, with proper financial and fiscal planning, it may be possible to eliminate the tax liability associated with the deferral altogether, resulting in absolute tax savings.
Advantages of tax deferral
Tax deferral allows business owners to earn more money than if they otherwise paid personal tax on the money. By leaving surplus funds in the company, they can make investments with a greater amount of capital. The old saying rings true "it takes money to make money". Not only does this strategy defers taxes, but it also allows business owners to make more profitable and lucrative investments because more capital is at their disposal.
Another common strategy employed by business owners is to delay compensation. Frequent amongst retired business owners, the strategy entails delaying the issuance of dividends from the corporation to themselves until they are in a lower tax bracket. By doing so, they can take advantage of lower personal tax rates. As a result, their tax liability will be significantly diminished, which means they keep more money in their pocket. Although this strategy evidently benefits retired business owners, it can find application in other low-income situations such as maternity leave or a sabbatical.
Another benefit of holding money in your corporation instead of remitting it to yourself personally pertains to extended periods of disability. A disabled individual usually has disability insurance, meaning he receives disability insurance payments. These payments are usually non-taxable, resulting in several years where corporate dividends can be an issued without incurring a high personal tax rate.