Incorporating your business is a significant step in the growth of your company, but it also brings about substantial changes in how you and your business is taxed. Understanding these changes is crucial for optimizing your tax strategy and ensuring compliance with regulations. Lets break down what happens to your tax situation when you incorporate, and how to navigate the new tax landscape.
1. Business Structure Before and After Incorporation
Before incorporating, most small business owners operate as sole proprietors or in a partnership. In these business structures, the company’s income is taxed directly to the owner at their personal tax rate. This means all business profits, no matter how much the business earns, are reported on your personal tax return, and you are personally liable for any debts or obligations.
When you incorporate, the business becomes a separate legal entity, meaning:
- The corporation itself is taxed on its income.
- You, as the business owner, are no longer personally liable for the company’s debts (with some exceptions).
- You can pay yourself a salary or dividends, which will be taxed at personal rates, but the corporation is taxed independently.
2. Corporate Income Tax Rates
One of the primary benefits of incorporating is the potential for tax deferral and savings. Corporations often pay lower tax rates on their earnings compared to personal income tax rates. In Canada, for example, small businesses can take advantage of the small business deduction, which provides reduced tax rates on the first $500,000 of active business income. This can result in significant tax savings for your business.
The corporate income tax rate on active business income ranges between 9% and 30% (as of 2025), depending on the province and whether the business qualifies for the small business deduction. By comparison, personal income tax rates can be much higher, depending on your earnings.
3. Salary vs. Dividends: How to Pay Yourself
Once incorporated, business owners have more flexibility in how they compensate themselves. You can choose to pay yourself a salary or dividends, each with distinct tax implications:
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Salary: Salary is a tax-deductible expense for the corporation, meaning it reduces the corporation’s taxable income. However, the salary is subject to personal income tax at your individual tax rate and Canada Pension Plan (CPP) contributions.
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Dividends: Dividends, on the other hand, are paid out of the corporation’s after-tax income and are subject to dividend tax rates, which are generally lower than personal income tax rates. However, dividends are not a deductible expense for the corporation, meaning they do not reduce taxable income. Keep in mind, there are rules governing how much in dividends a corporation can pay, and dividends can only be paid if the corporation has sufficient retained earnings.
Choosing the right mix of salary and dividends can optimize your tax situation, but it’s essential to consult with a tax advisor to determine the best strategy for your specific situation.
4. Tax Deferral and Income Splitting
Incorporation provides the opportunity for tax deferral. Since corporations are taxed on their income, you don’t have to pay personal taxes on the earnings you leave inside the company, allowing you to defer tax payments until you withdraw the money. This can be an advantageous strategy for growing your business and saving on taxes in the short term.
Additionally, incorporation allows for income splitting with family members. If they are shareholders of the corporation, you can pay them dividends, thus lowering your family’s overall tax burden. However, be mindful of income splitting rules in Canada, which are intended to prevent individuals from diverting income to family members in lower tax brackets for tax avoidance purposes.
How Origin Can Help
Incorporation can lead to significant tax benefits, but it also brings new responsibilities and complexities. At Origin Accounting & Advisory, we specialize in helping you navigate the financial implications of running an incorporated business. Whether you’re deciding on the best salary and dividend strategy or need guidance on maximizing tax deferrals, our team of CPAs is here to provide expert advice tailored to your unique situation.
If you’re considering incorporation or have already incorporated, contact us today to ensure you’re taking full advantage of the tax benefits and deductions available to you.
