So you’ve already incorporated your business, or it’s still under consideration. Let’s take a closer look at the major opportunities available through incorporation.
Generally speaking, if you’re the shareholder of a corporation then you’re not personally responsible for the debts of the company. In the case of a bankrupt business or one with significant losses, you wouldn’t lose more than your investment. However, that may not be the case if creditors have required you to provide a personal guarantee. In your capacity as a shareholder, you cannot be personally sued for debts incurred by the company. But, there’s still a possibility that you may be liable for debts of the corporation in another relationship with the corporation, such as a director.
Small business deduction
A Canadian Controlled Private Corporations (CCPC), which is a private corporation controlled by Canadian residents, is eligible for the small business deduction (SBD). These corporations are subject to a reduced tax rate on active business income up to the business limit for the year ($500,000 for years after 2009). This means that the combined federal and provincial tax rate for 2014 is only 15.5% on the first $500,000 of active business income. Any active business income in excess of the $500,000 limit is taxed at 26.5%.
Deferral of personal income tax
Depending on how much income your business generates and how much money you need to spend to maintain your lifestyle, you have the opportunity to defer a significant amount of income tax. To do this, you must retain income in the corporation – i.e., make more than you spend. You’re able to experience the benefits of the deferral until you distribute the income from the corporation to yourself and/or your family members who then pay personal income tax.
Investing income retained in the corporation
This goes hand in hand with the deferral advantages mentioned above. This is advantageous as it allows you to invest more after tax dollars in the corporation than you would be able to invest with after tax dollars personally if you had withdrew the funds from the corporation.
Life insurance premiums paid personally or by a corporation are usually not deductible. Since corporations are subject to a lower tax rate, they require less pre-tax income to pay for any such expenses. As a result, it is more cost effective to pay the premiums through the corporation. In addition to that, any death benefits paid to the corporation upon the death of the insured individuals increase the corporations Capital Dividend Accounts (CDA). This means that these funds can subsequently be drawn out of the corporation tax-free.
Selling your business
At some point, you’re likely going to sell your business – whether it’s by way of transferring shares to certain family members or selling your shares to a third party. When the shares you own meet certain criteria, you’re able to utilize the lifetime capital gains exemption (LCGE). The limit is $800,000 on certain transactions during 2014. What does this mean to you? Depending on the situation, this means that an individual can experience tax savings of approximately $200,000 on capital gains.
Remember that the LCGE is available to everybody. If you’re the sole shareholder of the company then only you’ll be able to use it. If your spouse and/or children are shareholders of the company then they’ll also be able to use it. So, depending on how many family members are shareholders, you can shelter in excess of $1.8 million from income tax.
Believe it or not, income splitting can be achieved when you’re not incorporated. However, with a corporation, you have far more opportunities. The two vehicles we’re talking about here are paying family members:
1. Salaries; and
Reasonable salaries can be paid for duties performed.
Dividends can be paid to the same individuals. If you have no other income, you can receive approximately $35,000 – $50,000 in dividends tax-free.
It is important to note that professionals have governing bodies that dictate specific rules that must be abided by with respect to their professional corporation. For example, there are separate rules regarding shareholders and professional liability considerations.