Benefit of Incorporation
One of the biggest advantages of incorporating a business is limited liability. This means that the liability of the shareholders is usually limited to the amount that they have invested in their shares in the corporation. However, many incorporated small businesses are not able to get bank loans without the personal guarantee of the shareholders, so this eliminates part of the advantage of limited liability. The personal assets of the shareholders are protected from lawsuits against the corporation. However, shareholders who are directors of the corporation can be held legally liable for some debts of the corporation (such as GST/HST and payroll taxes) in certain circumstances.
Another major advantage for a profitable small business is the income tax advantage. A Canadian Controlled Private Corporation, or CCPC, pays a much lower rate of federal tax (small business rate) on the first $400,000 (in 2007) of active business income than would be paid by an unincorporated business, due to the small business deduction. Active business income generally does not include investment income or rental income, which is taxed at regular corporate tax rates. The combined federal + provincial small business tax rate varies from approximately 16% to 22%, depending on the province. The threshold amount subject to the lower small business rate also varies between provinces. Keep in mind that this tax advantage is mainly a deferral of taxes until the profits are paid out to the shareholder. If all the profits are paid out to the shareholder as they are earned, leaving the corporation with little or no taxable income, then they will be taxed entirely as income of the shareholder, at personal income tax rates.
It is always recommended to seek professional advise from an experienced tax professional before going ahead and incorporating your business.
$750,000.00 Lifetime Capital Gains Exemptions
Another tax advantage of incorporation is the $750,000 capital gains deduction on the sale of shares of a qualifying small business corporation. One of the qualifications is that the corporation must be a CCPC with active business income.There is a $750,000 lifetime capital gains exemption (LCGE), which equates to a $375,000 lifetime capital gains deduction (1/2 of the $750,000 LCGE). The deduction can be claimed against taxable capital gains on the disposal by an individual of:
- qualified small business corporation (SBC) shares
- qualified farm property, and
- for dispositions occurring after May 1, 2006, qualified fishing property
The maximum LCGE that can be claimed by any individual was increased from $500,000 to $750,000, effective March 19, 2007, as a result of the 2007 Federal budget. This includes exemptions for small business corporation shares, farm property, fishing property, and any capital gains exemptions used in 1994 or earlier. The calculation of the deduction is done on CRA's form T657.
As the owner of a small business, should I pay myself a salary? What deductions would apply?
If your business is not incorporated, whether or not you pay yourself a "salary" is irrelevant for tax purposes because you and your business are considered a single entity by Canada Revenue Agency (CRA). You will be taxed on your net earnings from the business, which you will include on your personal tax return as self employment income. Thus, there are no "deductions" to be taken from payments you make to yourself. You are not required to pay Employment Insurance, but you will have to pay income tax and Canada Pension. When you file your tax return for your first year of self employment, you will have to pay any income tax and CPP premiums payable on your self employment income
If your small business is incorporated, whether or not you pay yourself a salary is a tax planning decision. Another option is to pay yourself (and other shareholders, depending on share structure) a dividend which is not deductible for the corporation. There are many factors to consider, and professional advice in this area is recommended. If you decide to pay yourself a salary, you will be required to deduct income tax and CPP premiums from your salary, but as owner of the business you might not be eligible to be covered by Employment Insurance