# Advice on whether to incorporate?



## ShannonC (Nov 16, 2012)

I'm just wondering if there is anyone in here who knows about personal income tax/business tax and may be able to help me. 

I work for myself (freelance writer) and have a number of different clients. I've always just filed under personal tax, but this year I'll be moving into the highest tax bracket and it's really a pretty big chunk I have to pay. 

I'm wondering if it would be better for me to convert myself into a small business for tax purposes? The hard part is I have very few write-offs since all I really need to work is my computer and the Internet. I work from home, so drive very little, don't ever meet with clients, and don't really need any supplies either. 

Would I still pay at a lower tax rate as a business though compared to a self employed individual? I'm in Alberta so I'm going to be looking at 39% for the highest portion of my income. 

Any advice would be great.


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## FrugalTrader (Oct 13, 2008)

From a tax perspective, the advantage of a corporation is if you have a significant amount of annual retained earnings. How much in earnings do you think you will keep in the company annually? Just a note that a corporation will require annual returns, along with a tax return every year. Ongoing fees (if you use an accountant) is about $1500/yr (at least it is in NL). Just a note that in Alberta, the corporate small business income (up to $500k) is taxed at 14%. The real advantage is if you have a spouse who is in a lower tax bracket and can make him/her a shareholder in the corporation. That way, you can dividend sprinkle out at a lower tax rate, which is an added benefit of a corp.


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## kcowan (Jul 1, 2010)

Tax management is the main advantage. You can write off your office and equipment as a sole proprieter. By retaining earnings, you defer tax (beyond the 14%) until you take the money. Normally this would be as a dividend, and preferrably spread around family members. If all you do is take the income as dividends in the current year, the combined corporate and personal rates will result in the same tax grab. IOW there is no advantage and higher costs in duplicate filings.


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## Homerhomer (Oct 18, 2010)

Unless you leave the profit in the corporation the only advantage of incorporating would be liability and ability to earn dividends instead of earned income.
Not enough details in your post to determine that incorporating would be right for you.


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## YYC (Nov 12, 2012)

I think we'd need to know more about your situation to offer any real advice. Does your spouse work? How much do they earn? How much income do you earn through your business? These types of questions. There are high costs to maintaining a corp and if you're taking all the money as income anyway, it works out pretty much the same from a tax perspective, so there needs to be another compelling reason to incorporate, such as dividend sprinkling mentioned above by FT.


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## ShannonC (Nov 16, 2012)

Thanks for all the replies. Yes, I was aware that it costs quite a bit more for tax filings, which is why I kind of have held off until now. 

I'm not really sure what you mean by this: "How much in earnings do you think you will keep in the company annually?" I could keep some money in the company and then just leave it there until I retire? Is that what you mean? 

I'm currently not married, and have no kids, but my current boyfriend (and we are at the stage of talking marriage..but it's a ways off), makes a higher income than me, so will also be in the highest tax bracket. 

This year I hope to bring in around 135k or so, maybe slightly more. 

By the sounds of it, in my situation there really is no advantage then?


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## FrugalTrader (Oct 13, 2008)

If you make $135k through your corporation, but withdraw everything personally, there will be no *tax* benefit of having a corporation.


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## ShannonC (Nov 16, 2012)

Okay, well let's say I only withdrew 50k (to live on) and the rest remained in the corporation. Does it just stay there until I retire and then I withdraw it each year at a lower tax bracket or how does that work? 

Sorry...probably a very elementary question. I'm just not sure how the whole business tax situation works.


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## MoneyGal (Apr 24, 2009)

In your situation, there is no (mathematical) tax advantage to incorporating that you cannot already get from existing tax deferral and tax sheltering opportunities (TFSA and RRSP accounts). If your spouse (if/when he becomes your spouse) is already in a high/the highest tax bracket, there's no real opportunity to take advantage of income-splitting with him. 

This is basically what others have said, so I'm just agreeing with them. I'll see if I can find an incorporation tax basics article to link to.


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## ShannonC (Nov 16, 2012)

MoneyGal said:


> In your situation, there is no (mathematical) tax advantage to incorporating that you cannot already get from existing tax deferral and tax sheltering opportunities (TFSA and RRSP accounts). If your spouse (if/when he becomes your spouse) is already in a high/the highest tax bracket, there's no real opportunity to take advantage of income-splitting with him.
> 
> This is basically what others have said, so I'm just agreeing with them. I'll see if I can find an incorporation tax basics article to link to.


Okay, great - thanks so much for this. That saves time finding an accountant to incorporate then. I'll be sure to max out my RRSP's and Tax-Free then...taxes are such a hit huge each year.


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## oedema (Jan 1, 2012)

ShannonC said:


> Okay, great - thanks so much for this. That saves time finding an accountant to incorporate then. I'll be sure to max out my RRSP's and Tax-Free then...taxes are such a hit huge each year.


Not so fast. First, how much money/ year do you actually need to live? If you're answer is really only $50,000, then there is considerable advantage to incorporation. On your current income you can only contribute $23,500 to an RRSP, whereas by retaining income within your corporation you defer >$60,000. At the end of your career whether funds are invested in an RRSP or corporation, there is little difference as far as growth but incorporation gives you more flexibility to do what you want with those funds. Lets leave TFSA out of the analysis because you have access to that regardless. Next up; if you pay yourself dividends you don't have to contribute to CPP, I think thats a plus, but more conservative minded people would likely opt to participate in CPP.

Before you do anything however you need to read and learn all you can about personal and corporate taxes, don't just rely on whats been advised here.


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## cardhu (May 26, 2009)

oedema said:


> At the end of your career whether funds are invested in an RRSP or corporation, there is little difference as far as growth


Well, here’s a not-so-trivial difference ... investment returns earned within the corporation are taxed ... investment returns earned within an RRSP are not. 

I agree the TFSA is neither here nor there.


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## oedema (Jan 1, 2012)

cardhu said:


> Well, here’s a not-so-trivial difference ... investment returns earned within the corporation are taxed ... investment returns earned within an RRSP are not.
> 
> I agree the TFSA is neither here nor there.


Yes, investment returns inside a corporation are taxed, however they can be taxed at an effectively low rate while growing your nest egg, and the funds can be withdrawn at lower tax rate than an RRSP during retirement. 

During your earning years you want to assign your dividends such that you retain as much of the active business income as possible and pay out any eligible dividends and capital gains (which would otherwise be taxed at a higher rate within the corporation).

http://www.theglobeandmail.com/repo...-paying-yourself-in-dividends/article1391246/
If you can find it, the CIBC paper mentioned is worth a look.


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## domelight (Oct 12, 2012)

ShannonC said:


> Okay, great - thanks so much for this. That saves time finding an accountant to incorporate then. I'll be sure to max out my RRSP's and Tax-Free then...taxes are such a hit huge each year.


 There are more questions you need answered. So following up with how the conversation has gone Here's my two cents.

1. If you can keep up the 13k profit for say close to ten years or more.
2. If you are comfortable taking out say 50K in dividends per year to live on.
3. If the suplus funds are left in the corp as a retirement fund.
4. You are not contributing to CPP if you use this manner. 

If all four of these are close to correct then I would look further into incorporationg. Lets look at the numbers

134K in alberta as a proprietorship = about 42k owning on the tax return.

134k in alberta as a corporation = about 19 k plus 50,000 in dividends on your personal = about 3,200 in personal tax plus 2k in legal/accounting.


So lets say ten years.... Ten years of personal tax = $ 1,340,000 (134k x 10yr) - $ 420,000 ( 42k x 10 yr) = $ 920,000 you get to keep.

Ten years of corporate tax = 1. $ 1,340,000 - $ 190,000 = 1,150,000 This is the money the corp has to pay out to you.

2. $ 1,150,000 / $ 50,000/yr = 23 years

3. $ 3,200 (pers tax) + $ 2,000 (legal/accounting) = $ 5,200 x 23 years = $ 119,600

4 $ 1,150,000 (point 1.) - $ 119,600 (point 3.) $ 1,030,400 you get to keep.

As you can see you're up about 110k by incorporating but a few other points...

+ The corp has an extra 23,000 per year available which you could invest and earn more interest income. (I personally like GIC's if you have no pension)

- No CPP contributions ( if you see this as a minus)

+ A good accountant coulld probably improve on the corporate scenario.

? if you can't maitain 134k per year the potential savings will likely be reduced.

? if the 134k goes up the savings would likely be increased. (or 134k/yr beyond the ten years)

comment.. Sounds like a potential 110k savings is probably worth paying a few hundred to consult with a good accountant and get some more information. I 
would likely have at minimum a one hour conversation to explore your long term goals and discuss the basics.


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## sharbit (Apr 26, 2012)

oedema said:


> Yes, investment returns inside a corporation are taxed, however they can be taxed at an effectively low rate while growing your nest egg, and the funds can be withdrawn at lower tax rate than an RRSP during retirement.


This unfortunatly isn't true. Active business income is taxed at a reduced rate. Investment income in a corp uses a different rate that is higher then the top personal tax bracket (44 2/3 to 50 2/3 based on your province. Google "Additional Refundabile tax on Investment Income (ART)". This additional tax is refunded once you pay dividends. The point is to make it so theres no to form a corporation simply to hold investments for reduced tax (though there are other ways to do this).


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## ShannonC (Nov 16, 2012)

Thanks again for all of the replies. This definitely gives me more to think about and perhaps sitting down with the accountant would be best just to be sure. 

I could easily live on 50k I would say - likely less. My mortgage is paid off... granted kids will (hopefully) come along in 3-5 years so that will increase my expenses, but right now I could comfortably live of 2500 or so a month. 

As for maintaining 135k...that would be really hard to determine. Over the last few years my income has gone up quite well with each year, but I work freelance, so there's never any guarantee. I hope I can sustain it, but again, when kids come, I may not be able to work the hours I do right now (I do work quite heavily).


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## Homerhomer (Oct 18, 2010)

oedema said:


> Yes, investment returns inside a corporation are taxed, however they can be taxed at an effectively low rate while growing your nest egg, and the funds can be withdrawn at lower tax rate than an RRSP during retirement.
> 
> .


No, they are taxed at a higher rate, and the only advantage would be over investments in non registered personal accounts since you are starting with a higher base (lower corporate tax on operating profit v personal marginal tax rate).


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## MoneyGal (Apr 24, 2009)

domelight said:


> There are more questions you need answered. So following up with how the conversation has gone Here's my two cents.
> 
> 1. If you can keep up the 13k profit for say close to ten years or more.
> 2. If you are comfortable taking out say 50K in dividends per year to live on.
> ...


1. This model assumes no RRSP contributions if she does not incorporate. 

2. Coupled with the higher tax (than you have estimated) on investment earnings in a corp account, I continue to think there's no financial advantage - or it is very slight if it's there at all. I didn't run any numbers but I have modelled this scenario many many times. 

It isn't that the OP shouldn't incorporate - it is that there is likely little to be gained if she does incorporate. The existing mechanisms are sufficient at this point.


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## oedema (Jan 1, 2012)

Homerhomer said:


> No, they are taxed at a higher rate, and the only advantage would be over investments in non registered personal accounts since you are starting with a higher base (lower corporate tax on operating profit v personal marginal tax rate).


The investment income is only taxed at a higher rate if it is retained in the corporation. This is why you should distribute any investment income in the fiscal year it is earned as eligible and capital dividends. Effectively you pay tax on the investment income just as if those investments were held personally.


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## Young&Ambitious (Aug 11, 2010)

Here's some reading on the above:

http://www.milliondollarjourney.com/dividend-investing-strategy-invest-through-your-corporation.htm


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## Homerhomer (Oct 18, 2010)

oedema said:


> The investment income is only taxed at a higher rate if it is retained in the corporation. This is why you should distribute any investment income in the fiscal year it is earned as eligible and capital dividends. Effectively you pay tax on the investment income just as if those investments were held personally.


Yes, I agree with that.


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## MoneyGal (Apr 24, 2009)

Yes, and if our OP only needs $50K to live on, and has a paid-off mortage, no dependent family members, and a spouse (spouse-to-be, perhaps) in the same income tax bracket, what is she going to do with the paid-out dividends? She won't have RRSP room to shelter them, only a TFSA.


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## Homerhomer (Oct 18, 2010)

MoneyGal said:


> Yes, and if our OP only needs $50K to live on, and has a paid-off mortage, no dependent family members, and a spouse (spouse-to-be, perhaps) in the same income tax bracket, what is she going to do with the paid-out dividends? She won't have RRSP room to shelter them, only a TFSA.


Why not, the income she takes from the corporation in form of wages to cover her living expenses will create rrsp room.
IMO if she can cover her living expenses, draw enough salary to max out rrsp/tfsa, leaving the remaining profits in the corporation and invest in dividend producing shares it may make sense from the tax point of view in comparison to earning everything as self employed.


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## MoneyGal (Apr 24, 2009)

Yes, there will be an optimal mix of salary and dividends to create RRSP room (requires payment into CPP). I was responding to the model set out by Domelight, who suggested she *only* take out dividends. 

If she draws sufficient income to maximize RRSP contributions ($23,820 is the 2013 upper limit), then how much is she retaining in the corp? Something like $30K per annum in her top-earning years, right? The need for a corporate tax return ($1500-$2500 per annum) is a relatively large drag on those retained earnings. Large enough that I personally would argue (have argued) that there isn't sufficient benefit to incorporating. There is potentially *some* benefit.


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## Homerhomer (Oct 18, 2010)

MoneyGal said:


> Yes, there will be an optimal mix of salary and dividends to create RRSP room (requires payment into CPP). I was responding to the model set out by Domelight, who suggested she *only* take out dividends.
> 
> .


I wish poeple would use the qouting function more :boxing: , sorry I thought you were responding to me :distress: ;-)
You have no disagreement from me re costs and potential benefits, I often tell poeple that there is more to it than just paying dividends and lower corporate tax rate ;-)


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## MoneyGal (Apr 24, 2009)

Internet High Five!


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## domelight (Oct 12, 2012)

MoneyGal said:


> 1. This model assumes no RRSP contributions if she does not incorporate.
> 
> 2. Coupled with the higher tax (than you have estimated) on investment earnings in a corp account, I continue to think there's no financial advantage - or it is very slight if it's there at all. I didn't run any numbers but I have modelled this scenario many many times.
> 
> It isn't that the OP shouldn't incorporate - it is that there is likely little to be gained if she does incorporate. The existing mechanisms are sufficient at this point.


 Actually I agree with you (especially in Alberta) However my goal was to get her to go see an accountant. I'm sure you would agree this question seems to get asked alot on this forum. and it is almost impossible to give proper advice without a face to face conversation.


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## ShannonC (Nov 16, 2012)

Thanks again for the replies and yes, I'm going to do just that. I called and set up an appointment with a new accountant today (got a recommendation from a friend in the industry). I gave him a brief run-down of my situation and he thinks there are likely some ways we can set this up better, so we'll see what he says. He mentioned that if I don't need my full earned income to live, then it would likely be beneficial for me to incorporate...so similar I think to what's been said here. 

He even does the consults at no charge... so that's a huge bonus.


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## PuckiTwo (Oct 26, 2011)

MoneyGal said:


> Yes, there will be an optimal mix of salary and dividends to create RRSP room (requires payment into CPP). ......





domelight said:


> ......You are not contributing to CPP if you use this manner.


IMHO it would be a real mistake if you didn't contribute to CPP. You are probably not thinking of retirement yet, I didn't either. Most of my life I have been self-employed and during that time did not contribute to CPP. Now in retirement it shows in my payments I get through CPP and I wish I hadn't been so dumb. You may want to ask yourself: will you always earn enough in the next 30/40 years that you have sufficient funds in retirement? Life is an unforeseeable animal. At the moment when you set up your company CPP contributions may sound like wasted money you could use for something else. However, contributions to CPP give you a (hopefully) guaranteed retirement income. Only a suggestion.


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## marina628 (Dec 14, 2010)

My husband and I both pay the max CPP along with our business share about $4600 each a year.I am sure there are some loop holes to get around that but we rather have that security .This year we don't need any income from our business but we are still taking about $53,000 each just for the CPP .I won almost $200,000 tax free this year


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