When to Incorporate
We recently published a blog post on small business corporate tax rates in British Columbia heading downwards to 11.5% on the first $500,000 by 2019. This reflects a 15% reduction in taxes from the current 13.5%. Considering that taxes are a big-ticket expense item for businesses, a 15% reduction is a huge discount. However, upcoming corporate tax rate reductions are only advantageous to businesses that can leverage them.
Successful proprietors are often burdened with personal tax bills that are almost always much higher than anticipated. This is because in BC, the personal tax rate is 40.7% for taxable income above $105,593 and this rate peaks at 45.8% for all taxable income above $151,051. There are also employer and employee portions of CPP premiums that need to be paid, which max out at $4,960 per year.
As burdensome as personal tax rates can be, the benefits to incorporating, given lowering corporate tax rates, must be carefully considered. Regardless of the corporate tax rate (which currently stands at 13.5%), businesses must be profitable enough to reap the benefits of a lowering corporate tax rate. So what is “profitable”? Well, a rough calculation tells us that at least $50,000 should be retained in the corporation after the owner has paid for all business expenses AND all personal expenses (including clothes, mortgage, school tuition, social club membership, vacations, etc.).
Family Tax Cut
Another recent tax change, which provided tax relief similar to income splitting is the Family Tax Cut, which came into effect in 2014. The Family Tax Cut provides a maximum $2,000 tax reduction at the federal level for couples with young children. This tax cut is beneficial to those couples where one spouse earns considerably more income than the other spouse, and where the other spouse has chosen to stay home full-time or part-time to care for the children. In brief, the Family Tax Cut provides some benefit to proprietors, similar to the income splitting benefits available under incorporation. However, with the Family Tax Cut maxing out at $2,000 per family, a successful proprietor would be further ahead using a corporation to enact full income splitting opportunities.
Standard prerequisites to consider incorporation
Despite falling corporate tax rate for Canadian controlled private corporations, the prerequisites to consider incorporation have not changed, which are high profitability and the need to shelter retained earnings. It is also worth noting that certain types of businesses need incorporation to shelter against litigation so tax planning would not be the primary consideration in these cases.
As well, if the business operates in a city such as Vancouver with high rents and operating costs, one has to keep in mind that the bar where incorporation makes sense is generally set much higher than average.