# Should I incorporate?



## kork (Jun 9, 2012)

Hey everyone. Sorry, this post got long, but I wanted to provide some details.

I've been employed full-time for the past 10 years and have also been running my own business with yearly growth as a sole proprietor. Each year I learn more and more about taxes as I do all my own returns using TurboTax (Unincorporated business).

My father always told me _"nobody cares more about YOUR MONEY'S best interests than you"_ and with that advice I've always tried to manage my own finances from planning to taxes.

So my situation is this. 


I work full-time with an $80k salary
I own a business (sole proprietorship) with a yearly income of about $130k
My wife is a stay-at-home mom and she is an independent contractor for me at $2k a month. She takes care of the accounting, administration, etc along with other tasks such as software testing, etc. She also has some income as a sub contractor from other companies that she does minor admin work for. She does not currently collect HST but her income is under $30k.
I utilize sub-contractors and they represent about $50k a year ballpark.

Overall, my "personal income" is around the $130k mark. This year I'm eating up the remainder of my RRSP contributions ($40k) which brings my taxable income down to around $90k or so. So all in all, my wife pays reasonably low taxes with an income less than $30k and I only pay taxes on $10k additional to my business.

But this next year with my RRSP contributions capped out and having already billed 48% more this year over last with my company I'm curious if I would benefit from incorporating my business or some other strategy?

So I see some options.


Should I stay a sole proprietor and hire my wife full-time (this August both kids are full-time in school) at a reasonable salary, say $40k a year?
Should I incorporate my business, have my wife get her own full-time job and pay out dividends with both of us as shareholders? Would that matter? Are dividends taxed differently based on income level?
Should I incorporate and just pay myself a salary or just dividends?
Should I incorporate and just leave a bunch of the earned money in the corporation for a rainy day or later withdrawal?


I'm 34 years old (wife is 41 and kids are 6 and 4) and still plan on having some time until retirement.

I really want to do things the right way. I'm not interested in shady tax sheltering strategies, but if there are options available that allow me to stick some extra savings in my girls RESP's or a family vacation, I'd like to take advantage of that. I've also been doing my own taxes for the last 10 years. Would it make sense to get an accountant involved or should I continue doing what I'm doing and learning a bit more each year? I'm in total control of by business finances and like having that control (aka - thanks Dad!)


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## kork (Jun 9, 2012)

Anyone? Would love to have some thoughts?


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## MoneyGal (Apr 24, 2009)

Kork. I've been trying to get to your post. IMO you are right on the cusp of having incorporation be a reasonable proposition. HOWEVER: there are some relatively big decisions you need to make. 

You need professional advice; a message board format is not going to cut it. Specifically: you should start looking at the implications of salary vs. dividend in terms of CPP contributions and CPP income in retirement, and you should start to think about whether the main purpose of the corp is to build wealth over time or to income split in the present (because these two strategies will lead to differing amounts in the corp when you want to wind it down/sell/start drawing income - and you don't want to have your options in the future constrained by some decisions you made unawares in the present). 

As a basic first step, though, if your strategy is tax avoidance, you can start to build some simple spreadsheets which will contrast the tax implications of various options. You've come up with four scenarios - you could start figuring out the implications of each choice, putting numbers to options. This will also start to show you what you DON'T know or don't feel comfortable with, which will help set up your discussions with a professional advisor.


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## kork (Jun 9, 2012)

MoneyGal said:


> Kork. I've been trying to get to your post. IMO you are right on the cusp of having incorporation be a reasonable proposition. HOWEVER: there are some relatively big decisions you need to make.
> 
> You need professional advice; a message board format is not going to cut it. Specifically: you should start looking at the implications of salary vs. dividend in terms of CPP contributions and CPP income in retirement, and you should start to think about whether the main purpose of the corp is to build wealth over time or to income split in the present (because these two strategies will lead to differing amounts in the corp when you want to wind it down/sell/start drawing income - and you don't want to have your options in the future constrained by some decisions you made unawares in the present).
> 
> As a basic first step, though, if your strategy is tax avoidance, you can start to build some simple spreadsheets which will contrast the tax implications of various options. You've come up with four scenarios - you could start figuring out the implications of each choice, putting numbers to options. This will also start to show you what you DON'T know or don't feel comfortable with, which will help set up your discussions with a professional advisor.


Thanks for the feedback. I'm not looking for tax avoidance as we all need to pay and I've been pretty lucky in life. However, I've been focused on saving for retirement since I was in my early 20's and would rather find a way to keep my money than give it up as I'm sure we all would. I work harder and end up paying more. There's a cost of diminishing return for personal income and I'm sure there's a point where "structure" or "playing smarter" will allow me to keep more of my hard earned dollars. Like you said, I think I'm right on the cusp of that border.

Is there anything specific I should look for when seeking professional advice? i.e. Are there "consultants" who would be more interested in setting up structure and guidance as opposed to doing my yearly taxes, etc?


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## MoneyGal (Apr 24, 2009)

You don't want anyone who uses the term "consultant" IMO. At this stage of the game I'd look for a CA who does small-biz incorporation work. If you decide to incorporate, then you should find a lawyer.


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## motd (Mar 19, 2013)

MoneyGal said:


> If you decide to incorporate, then you should find a lawyer.


I've incorporated earlier this month but my accountant has not mentioned anything about getting a lawyer. I'm an IT consultant, single employee, first time diving into this "working for myself" ... what would a lawyer be used for in that situation? If preferred, my first post outlining my situation is here to reply into instead.


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## kork (Jun 9, 2012)

motd said:


> I've incorporated earlier this month but my accountant has not mentioned anything about getting a lawyer. I'm an IT consultant, single employee, first thing diving into this "working for myself" ... what would a lawyer be used for in that situation? If preferred, my first post outlining my situation is here to reply into instead.


Actually, I'd be curious about this as well. What value would a Lawyer bring to the table?


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## Jagas (Feb 11, 2013)

MG's suggestion to seek professional advice is sound. A CA will likely have you compare your expected Corporate income to your required cash flow needs from that income. The greatest value of incorporating comes from the potential tax deferral in my opinion. You should be looking at what the amount of your tax deferral may be, consider what you can earn on that amount and compare it to the additional costs associated with incorporating. There are costs of incorporating as well as annual maintenance costs for the Corporation. Unless you are able to handle the Corporate tax filings on your own, the costs are very likely to outweigh the benefits in the early term. In general the following will make incorporating more attractive:

- The greater the difference between net income in the Corporation and what you need to draw from the Corporation to fund your lifestyle, the better
- The longer the time frame you intend the funds to stay in the Corporation before ultimate withdrawal and resulting personal taxes, the better
- The more income you can earn on those funds in the meantime, the better
- The lower the maintenance costs associated with the Corporation, the better

Be realistic about your abilities in regard to creation and maintenance of a Corporation. I see lots of advice to handle the incorporation process yourself yet I also see a lot of situations which cost far more in the end because someone has tried to do this themselves and completely bungle it up requiring a lot of professional assistance to correct things after the fact. Same goes for maintenance. Yet there are many cases where people can handle both of these aspects on their own just fine.


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## motd (Mar 19, 2013)

Funny on the timing but I just got a copy of my newly signed incorporated contract emailed to me from my recruitment agency ... there's one thing a lawyer would have been good for; contracts review!

I'm sure there's more though. Must be paying them the good money for additional legal advice during business operations?


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## MoneyGal (Apr 24, 2009)

Lots of corporations with minor children (or for other family reasons: multigenerational income splitting, children from previous marriages, incorporation as part of a marital breakdown, etc.) use various forms of discretionary trusts to hold shares, split income, protect assets, etc. Once you start using trusts, you need a lawyer; DIY trust law isn't something I'd recommend.


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## Jagas (Feb 11, 2013)

*stdefu1st*



motd said:


> I've incorporated earlier this month but my accountant has not mentioned anything about getting a lawyer. I'm an IT consultant, single employee, first time diving into this "working for myself" ... what would a lawyer be used for in that situation? If preferred, my first post outlining my situation is here to reply into instead.


IT Consultant. Single Employee. Incorporation. >>>Off topic, but if your accountant has not already gone over the risks of being categorized as a personal services business by CRA, consider doing a bit of research on the topic and follow up with them.


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## MoneyGal (Apr 24, 2009)

:encouragement:


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## motd (Mar 19, 2013)

Both my agency's placement contract as well as my accountant have been working with me on making everything for business-to-business relationship only. Thanks for the advice tho, definitely need to let each other be aware of the PSB/PSC which will raise the red flag at CRA.


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## OptsyEagle (Nov 29, 2009)

I didn't read this entire thread but you may want to review the current budget change on taxation of dividends on small businesses, before you make a final decision. Here's a blurb on it:


_On the small business side, Budget 2013 proposes to reduce what’s known as the gross-up factor on dividends to 18 per cent from the current 25 per cent. The dividend tax credit would also be reduced. 

This would affect small business owners — not investors who receive dividends from large corporations. 

“It could affect a lot of companies. Anyone who’s operating a small business as a corporation and has paid dividends to family members, the tax rate will be higher.”

“It’s a technical tax change and will have an impact on small firms. It will mean that dividends are higher taxed in 2014,” _


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## kork (Jun 9, 2012)

So I met with an accountant and explained my situation. 

Of the various things that were discussed, I had indicated that it would be nice to be able to take the money from my own company and keep it in the corporation. Right now it's personal income and I really don't need it. But I'm paying lots of tax on it and I've already maxed out my RRSPs.

Their suggestion was to incorporate my business and have my wife and I both be shareholders of the corporation. Basically, money earned by the corporation is not paid out to either of us. It just sits in the corporation over time and is taxed as a business.

So in 15 years when I'm 50 and my wife is 57, let's say the company had been earning $80k yearly for those 15 years. That would be $1.2 million. The accountant suggested that I'd be able to stop working, as would my wife and be able to take around $40k per year as dividend payments and it would be virtually tax free as long as we had no other income. That would then last another 15 years...

So careful planning now would allow me to "retire" at 50 and then when the corporation $ runs out, that's when, a 65 I'd begin withdrawing from my RRSP's.

Am I understanding this correctly or is there something odd with this setup? We spoke about lots of things, but this one stood out as I'd love to be able to have that sort of safety cushion in case of disaster or nest egg saved up for "early" retirement.

Looking for feedback please???


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## MoneyGal (Apr 24, 2009)

Yes, the basic premise is accurate and has been discussed here a handful of times. 

Notes: 

AMT may be payable in situations when you / you and a spouse have exclusively dividend income. 

Eligible dividends are not a risk-free source of income and they are generated by entities that have had to pay take at a rate of about 26-31%, meaning that they may not be the most tax-efficient source of income available, when considered from end to end. 

It can be difficult to create a compensation strategy that only includes eligible dividends, and the requirement that eligible dividends must be Canadian can result in reduced returns / greater risk in contrast with other alternatives.


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## kork (Jun 9, 2012)

Thanks MoneyGal. A few questions that have popped into my head.

1. What is an "eligible" dividend?

2. What would the tax rate be for a small business in Ontario with under $100k of earning a yea?

3. If I'm doing most of the work for the corporation and my wife is doing the other portion such as testing, banking, etc, do we need to draw a salary or income at all, or can the corporation keep all the money it earns and not pay anything else out? 

4. Do dividends need to get paid out yearly or can a company earn $80k a year with no expenses, sit on it and then slowly trickle it out after a decade or so?

Please correct me if I'm wrong but right now my I pay around 35% tax on my income between $87k - $135k and 38% on anything above (for the most part) in Ontario. Alternatively, if I left the money in the corporation it would be taxed at 25%. 10%-13% lower. However, in the future, I may end up paying tax on that dividend income or the rules may change or the companies "investments" could rise or fall much the same way my own investment would...

Am I viewing this correctly or am I missing some details? It seems that at a vanilla point of view, it's tax differal with the benefit of paying taxes by timing things properly?


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## MoneyGal (Apr 24, 2009)

I guess the question I'd have is whether it makes sense for you to pursue this as a strategy with this level of understanding.


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## kork (Jun 9, 2012)

I believe it does. I'm not making any decisions, I'm looking to understand more. Hard to do that without asking questions or seeking advice.

I sought out an accountant because you suggested to do so MoneyGal. That resulted in additional questions. I'd rather hear opinions and opposition from different people than to accept it from a single source. I could also Google it or find answers in other ways.

As the saying goes, "Be careful whose advice you buy, but be patient with those who supply it."

This forum is a group of people with varying opinions and ideas. My understanding grows only by asking questions. I'm not looking to do it all myself, but I am looking to understand better what's happening. I'm being careful with the advice from the accountant since I know where his interest lies. I'm being patient with the advice in this forum, hoping to learn and understand better before pursuing anything.


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## OptsyEagle (Nov 29, 2009)

Don't forget to read my post above about changes put forth in the last budget. The idea that you can take oodles of money out in dividends and pay no tax is being reduced. I doubt it is being reduced by that much, but your accountant might not have been aware of these changes. That is why I posted them.


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## kork (Jun 9, 2012)

OptsyEagle said:


> Don't forget to read my post above about changes put forth in the last budget. The idea that you can take oodles of money out in dividends and pay no tax is being reduced. I doubt it is being reduced by that much, but your accountant might not have been aware of these changes. That is why I posted them.


Yes, I saw that - Thank you.


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## Charlie (May 20, 2011)

1. An "eligible" dividend is generally one paid by canadian public companies or out of retained earnings on which you have paid high rate tax (active income > $500K in a year). The difference between 'eligible' and 'not eligible' dividends is the end rate of tax applied to each. Foreign dividends are taxed the same as interest income.

2. Your small business rate would be 14%-15%. May be slightly lower right now...but the winds suggest a wee bump up in the making. This is the rate on active income only. There's a much higher rate on investment income (more on that later).

3. You don't need to draw a salary out at all. Without a salary you may lose RRSP eligibility, child care deductability and other matters, but those are the things you'd review with your accountant annually to structure your earnings to your best benefit.

4. Dividends do not have to be paid out either....though again, it may be best to do so.

Regarding the investment income.....a corporation effectively pays the highest marginal rate (or higher) on investment income that is not flowed through to the shareholder. Once the income is flowed through to the shareholder, through dividends, the shareholder pays tax at his or her marginal rate (which is almost always lower, and certainly no higher). So it is generally beneficial to pay out investment income earned by a corp to the shareholder. Again...this is what your accountant gets paid to figure out.

If you anticipate $50-$80K+ of annual income in excess of what you need in the short term, and you're comfortably not in danger of being deemed a Personal Business Corp, incorporation makes a lot of sense for you. As long as you anticipate this being a fairly long term deal, and don't mind the extra bookkeeping and costs.

Don't concern yourself with the budget pronouncement on dividends. It was a very small change (less then 2% change in tax) that corrected a discrepancy in the flow through of income.

Congrats and good luck.


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## kork (Jun 9, 2012)

Thank's Charlie! Very helpful. Now I can go back to my accountant with some clarification and understanding.

Much appreciated!


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