Should You Incorporate Your Business in Canada? Key Tax Considerations

One of the most common questions business owners ask is: “Should I incorporate my business?” The answer depends on more than just tax savings—it’s about understanding how incorporation works, what benefits it offers, and whether it makes sense for your specific situation.

The Truth About Incorporation and Taxes

A widespread misconception is that incorporation automatically saves you money on taxes. In reality, incorporation does not eliminate tax—it defers it.

Example:

• Your business earns $100,000 in profit.

• If you incorporate and withdraw the entire amount as a dividend, you’ll likely end up paying the same (or possibly more) tax compared to operating as a sole proprietor.

However, if you only withdraw $70,000 for personal use and leave $30,000 inside the corporation, that $30,000 is taxed at the lower corporate tax rate. You haven’t avoided tax—you’ve deferred it until the money is eventually taken out for personal use.

That’s the main tax advantage of incorporation: deferring personal taxes on income you don’t immediately need.

Common Questions About Incorporation

1. When does it make sense to incorporate?

Ask yourself two key questions:

• How much profit does your business generate annually?

• How much of that profit do you need to cover personal expenses?

If you need all your business income to live on, there’s little to no tax benefit from incorporating. In this case, incorporation might still make sense for legal protection, but not for tax deferral.

2. What if my profits are higher than my personal needs?

If your business consistently earns more than you require for living expenses, incorporation could be worth exploring.

• If the surplus is only $10,000–$20,000, the tax deferral exists, but accounting and corporate filing fees may offset much of the benefit.

• If the surplus is larger—or expected to grow in the future—incorporation can make more financial sense.

3. How much extra income justifies incorporation?

There’s no one-size-fits-all answer. If you currently have only a small surplus but expect it to grow, incorporating sooner rather than later may save you the hassle of transitioning later. The timing doesn’t have to be perfect, but future growth expectations are an important factor.

4. What’s the process for incorporating?

It’s not as simple as opening a corporation and continuing business as usual. You’ll need professional help from both an accountant and a lawyer.

Key steps include:

• Selling your existing business assets—including goodwill and client lists—to the new corporation.

• Using a Section 85 rollover to transfer these assets at cost instead of fair market value, avoiding immediate tax consequences.

• Considering GST/HST and provincial sales tax implications during the transition.

Without proper planning, the transfer could trigger unnecessary taxes, so professional guidance is essential.

Final Thoughts

Incorporation is not a universal tax-saving strategy, but it can be a powerful tool for businesses with growing profits and long-term plans. The main benefit is the ability to defer personal taxes on income you don’t immediately need, while also offering potential legal protections.

Before making the decision, carefully assess your profits, personal income needs, and future growth expectations—and consult with your accountant and lawyer to ensure the transition is done correctly.