Should I Incorporate My Business in Canada?

Deciding if you should incorporate your business in Canada is a major decision that can significantly impact your taxes, wealth, financial planning, and long-term goals.  

Why does it have such a big impact?

Incorporation offers benefits like liability protection and potential tax savings. Canadian individuals could pay tax rates of over 50% on business income. However, if they set up a corporation that earns the business income, it could pay as low as 9% to 12% depending on the province.  

But it isn’t the right move for everyone. We’ve seen many people incorporate before they should and waste thousands of dollars on accounting and legal costs.

Here’s a detailed flowchart and accompanying guide to help you understand when incorporation might be the right step for you. Please note that your situation may differ. If you’re interested in finding out if incorporating makes sense for you, contact a trusted CoPilot Tax specialist.

8 Steps to Decide if You Should Incorporate in Canada

1. Do You Need Liability Protection?

A significant benefit of incorporation is limited liability protection. This means if someone were to sue your business or your business faces financial or legal issues, the creditors would generally not be able to seize what you (the owner of the corporation) own, only the corporation owns.  

Example 1: Imagine you have a business where you offer advertising services. However, one of the ads you create for your client actually ruins a client’s reputation. If the client decides to sue you, the client would generally only be able to go after what the corporation owns, and not what you own personally (i.e. your home).   

Example 2: Imagine you own a rental property in a corporation and you also own your own home. There is an issue at the rental property (i.e. maybe a fire) and it causes damages to several houses around it. All the neighbours decide to seek legal action against you. The only assets that would be available to them are the assets in the corporation, not your personal home. 

If you operate in a high-risk industry or have significant assets to protect, incorporation could be very beneficial. However, there are important caveats and limitations of this liability protection that corporations provide. 

Caveats:  

• It’s important to remember that insurance can potentially offer protection in many of these cases and it might be worth considering how the cost of insurance compares to the cost of incorporating.  

• There are also instances where courts have looked-through the corporation to seize the assets of the owners. This is called piercing the corporate veil. It generally occurs where a shareholder might be negligent (i.e. not installing proper fire alarms) or there are unpaid wages/taxes. 

• If you’re a professional (doctor, dentist, lawyer), the laws generally dictate that liability protection wouldn’t be available for your professional corporation. 

 

• Yes, I need liability protection: You should consider incorporating but be aware of alternatives and the limitations. 

• No, I don’t need liability protection: Incorporating may not help much but it could still make sense, proceed to the next consideration. 

 

2. Do You Have Irregular or inconsistent Business Income?

If your income varies significantly year over year, incorporation can help you smooth out taxes by deferring personal income to years when your personal tax rate is lower.

Personal tax rates increase as you have more income. That means if you earn personal income of $200,000 in one year and then $0 in the following year, you will pay more tax then if you earn $100,000 in each of the two years. Without a corporation, it is difficult to spread your income evenly across two years and pay less tax. With a corporation, it becomes possible. However, incorporating comes with extra costs so there should be enough variability in your income and in your tax rates such that the benefits outweigh the costs. 

• Yes, my income is very irregular: Consider incorporating as it may help you pay less taxes across several years. 

• No, my income is steady: Continue to the next consideration. 

 

3. Dividends to Family Members

a) Can you Pay Dividends to Family Members without TOSI applying? and 

b) Are your eligible family members in significantly lower tax brackets?

The Tax on Split Income (TOSI) rules are complicated, and they can significantly affect the tax benefits of paying dividends to family members. If TOSI applies, then dividends to certain family members are taxed at the highest tax rate. If TOSI does not apply, dividends to certain family members may be taxed on their regular tax rate. This is important because if you have a spouse that doesn’t work, you may be able to pay him/her a dividend and use their low tax rates as opposed to you paying all the taxes at a higher tax rate. 

Incorporation may not be as beneficial if TOSI applies to your situation. It is not easy to find out if TOSI would apply in your situation or not. I would generally recommend you assume TOSI would apply unless you can qualify for an exemption. I would recommend speaking to a qualified advisor or our team at CoPilot Tax if you’re interested in finding out. 

• TOSI doesn’t apply, and family members are in lower tax brackets: Incorporation may help reduce the overall tax burden. 

• TOSI applies, or family members are in similar/higher tax brackets: Incorporation does not make sense. 

 

4. Is Your Personal Spending Significantly Less Than Business Income?

If you earn business income and earn more than you spend, having a corporation can potentially help you defer tax. This is because corporations have low tax rates on business income. Corporate taxes rates on business income can range from 9% to 12% depending on the province (it can also go as high as 27% under certain conditions). Compare that to personal tax rates which can go as high as 54% and you’re potentially looking at over 40% of tax being deferred each year.  

However, if you have personal expenses, you would need to pay yourself from your corporation in order to pay for those expenses. You would need to pay those high personal tax rates when you pay yourself from your corporation. But if you don’t need all the money that you earn to pay for personal expenses, then you can leave the excess income in the corporation and invest. However, this only works if your personal spending is less than your income. 

If your spouse works or you have other sources of income (i.e. a job), this could still apply. If those sources of income can cover a lot of your personal expenses, then you can use those sources of funds to pay for the personal expenses and defer tax through your corporation. 

• Yes, my personal spending is lower than my income: Consider the next step. 

• No, my personal spending is not much lower than my income: Incorporating may not sense as you’ll need to withdraw most earnings, leading to personal tax at higher rates.  

 

 5. Do You Have High-Interest Personal Debt?

Before incorporating, assess your personal debt situation. If you have high-interest debt (like credit card debt), it’s often better to focus on paying it off first before incorporating. This is because the main benefit of a corporation is to invest with the corporation. However, you’re unlikely to earn a better return than the high-interest debt you incur. 

• Yes, I have high-interest debt: Delay incorporation until there is no more high-interest debt. 

• No, I don’t have high-interest debt: Consider your low-interest debt situation next. 

 

6. Low-Interest Debt

a) Do You Have Low-Interest Personal Debt? And

b) Do You Want To Prioritize Paying Off Debt Before Investing?

  If you have low-interest debt (like some student loans), it could affect your decision to incorporate. The decision depends on your priorities, your comfort with debt, and the expected return on your investments. Incorporation might make sense if you’re comfortable keeping the debt and investing your excess income instead of repaying the debt right away. It generally makes sense if the after-tax return of your corporate investments (whether it be in securities, real estate, the business itself) exceeds the interest rate on the debt. It’s important to consider that the interest rate on the debt is guaranteed whereas investments usually come with a risk. 

• Yes, I have low-interest personal debt and I want to pay off low-interest debt before investing: Incorporation may not be the priority as you will need all the funds personally to pay off the debt. 

• No, I don’t have any low-interest personal debt or I’m okay with keeping low-interest debt and investing instead: Proceed to the next consideration. 

 

7. Do you need personal savings for something (i.e. down payment beyond RRSP, TFSA, FHSA, personal-use luxury car, personal emergency fund)?

This is not in the flowchart, but it is an important consideration regardless. 

If you require personal savings for a short-term goal or you don’t have a personal emergency fund, you may want to defer incorporation until you’ve saved for it. This could be for situations where you are saving for a really big down payment that the balance in your RRSP, TFSA, FHSAs won’t cover or a personal-use car (which also won’t be covered by a TFSA). 

• I need personal savings for a short-term goal or I don’t have a personal emergency fund: Incorporation may not be the priority. 

• I don’t need personal savings from a short-term goal and I have a personal emergency fund: Proceed to the next consideration. 

 

8. Are You Interested in Investing in:

A) Securities; or 

B) Real Estate/Reinvest in Your Own Business/Other Private Businesses/Unsure?

Your investment strategy affects the timing of incorporation. Let’s break this down: 

Scenario A: Investing in Securities 

Securities includes stocks, bond, REITs, GICs, ETFs, mutual funds, etc. If your plan is to invest in these investments, then it could delay incorporation. This is because these investments could be made in your RRSP, TFSA, and FHSA. And it is generally better to invest in these accounts before investing in your corporation. Maximize your RRSP, TFSA, and FHSA (if eligible or suitable) first. Incorporation becomes beneficial when you expect your earnings to exceed: 

• Personal spending 

• Needed personal savings/emergency fund 

• Annual RRSP, TFSA, and FHSA contributions 

If these are exceeded, you can leave the surplus income in the corporation for tax-efficient investing. 

Scenario B: Investing in Real Estate/Your Business/Other Private Businesses/Unsure 

If your plan is to invest your excess funds in real estate, re-invest in your business, invest in other private businesses, or you’re unsure of what you’re planning to invest in, you don’t need to delay incorporation any further. You can set up a corporation and build up low-taxed corporate funds to make those investments. If you’re unsure but you later decide to invest in securities, you can always contribute to your RRSP, TFSA, and FHSA at a later date.  

Final Thoughts 

Determining if you should incorporate your business in Canada depends on your personal and financial circumstances. While liability protection is a clear advantage, other factors such as income stability, debt, and investment strategies play crucial roles in deciding if and when to incorporate. If you’re interested in deciding if you should incorporate, contact us today to examine if it makes sense for you to incorporate.