Greater Cash Flows to Buy Assets or pay debt

Currently, a Canadian owned small private company in BC pays significantly lower taxes then an individual operating a non-incorporated business.  This fact is useful if you intend to buy business assets or need cash to pay down business debt.

Each $1,000 of small business income in a company will attract $135 of income taxes.  The net residual cash after taxes is $865 when income is earned in a company.

In contrast, if you operate a business personally, the tax rates range from 20% to 44%.  The range is dependent on your income level.  This means for $1,000 of income earned, you are left between $560 to $800 ($1,000 of income less taxes of $440 to $200) after taxes are paid.

A comparison of the above illustrates there is more cash available when your business income is taxed in a company.  Specifically, operating a company will leave you between $65 to $305 more cash for each $1,000 of income.  This excess cash can be used to finance asset purchases such as a building or service debt payments.

Income Splitting with dividends

If you own a business personally you cannot legitimately split income with your spouse if he/she is not involved in the business.  This means you are completely burdened with any income taxes.

However, if you operate as a company and structure your spouse as a shareholder, dividends can be legitimately used to split income.  This is permissible even if your spouse is not actively involved in the company.  For 2010 approximately $30,000 of dividends can be paid to your spouse tax free (assuming your spouse has no other income).  The tax savings can be as much as $10,000 ($30,000 dividends x 33% tax rate for dividends) per year if you are a high incomer earner.

Income Splitting with dividends to trusts

Assume you operate a small business company.  Dividends paid to you attract up to 33%  in personal taxes.  However, family trusts holding shares in your company can be utilized legitimately to funnel dividends to your spouse, or even adult children tax free in the years when they are attending university.  You can avoid up to $10,000 ($30,000 of dividends at 33% tax rate) in taxes per person annually this way.

Tax Free Sale of Your business

If you have built up a business and want to retire, the next step is to sell your business.  If you operated a business personally the profits from the sale will be taxable.  The tax rates vary depending on the type of assets you are selling.  However, the key idea is that taxes will have to be paid if you sell your business for a profit.

In contrast, if you structured your business to be a company, up to $750,000 of gain on the sale will be tax free.  Tax laws allow this on small business corporation shares that meet certain criteria.  Additionally, if you structured your spouse to be a shareholder of your company as well, he/she is entitled to a separate $750,000 exemption.

In summary operating a company has definite advantages.  Consult your advisor to determine if they apply to you.

A. Ko, CGA, CA

Editors note:  Thanks Alex for this great contribution.  Definite food for thought for people considering incorporation.