Bob Gauvreau explains tax implications of incorporating in Canada: the federal small business deduction reduces the active business corporate tax rate to 12.2% on the first $500,000 of net income, creating an incentive to earn inside a corporation. He contrasts two main ways an owner can withdraw funds — salary (a corporate deduction but taxed at higher personal rates and subject to CPP/EI withholding) and dividends (not deductible to the corporation, but typically taxed at a reduced personal rate because the corporation already paid ~12.2%; dividends avoid CPP contributions and may allow roughly $45,000/year to be withdrawn tax-free due to the dividend tax credit).
Questions this video answers
12.2% on the first $500,000 of net active business income.
The first $500,000 of net income.
About $7,000 per year.
Somewhere upwards of $45,000 per year (tax-free due to the dividend tax credit).
Chapters
Okay, so let's talk about the tax implications of setting up a corporation anywhere in Canada. So the idea is, first and foremost, when you set the corporation up, as long as it's active business that's being incurred in the corporation, we're going to be able to get access to what's called the small business deduction. Small business deduction is a huge credit for the corporation that brings our active business tax great rate down to 12.2%, 12.2% for the first $500,000 of net, not gross, but of net income. So this provides a really great incentive to earn inside a corporate entity. What happens as well in this case when we're dealing with tax consequences is it changes the options that we have as an individual to withdraw money from a company. We then have two options which will impact our taxes, which one is to go on a salary, which is a deduction inside the business. It's taxed at a higher rate personally subject to Canada pension plan and potentially employment insurance withholdings as well, and maybe even some income tax withholdings too. So there are a lot of source deductions that the company has to essentially withhold on behalf of your paycheck and remit to the government on a regular basis. The other option that we have as a shareholder of the corporation is, is to take a dividend distribution. Now, this is not a deduction in the company, but remember, the company is paying tax at 12.2%. I'd much rather pay 12.2% than 55% personally. So I'm okay without getting that tax deduction. I just want you to know that that's how that works. And because the company has already paid 12.2% tax, when I pull that money out as a dividend, it's a reduced tax rate. Typically, it's a reduced tax rate by about 12.2% to signify an equalization of salary or dividend and corporate tax payments. There is some benefit in many cases to using dividends. You're not subject to Canada pension plan contributions with respect to dividends, which will save you about $7,000 a year right now. In addition, depending on the amount that you pull out of your corporation with dividends, you can take somewhere upwards of $45,000 out per year without any tax having to be paid on that. Above that, we start paying tax on dividends. The reason we don't pay tax on that is that we get a dividend tax credit that essentially eliminates any of that income from being taxable on. On your personal on your personal circumstances. So those would be the two major considerations about the tax implications of for starting a corporation in Canada.
