The article “Should You Incorporate A Business To Save On Taxes?” was originally published on MoneySense on October 23, 2018.
Only if you can justify the initial and ongoing costs
Q: I was recently let go from my job and am planning on starting a handyman business. I am toying with the idea of starting a corporation. I am concerned that I have made too much money in 2018 from my previous job ($123,000).
Will I be taxed at a higher rate if I were incorporated and make some profits through my new business?
—Greg
A: People can make mistakes with incorporation. Some people who should incorporate don’t, and some people who shouldn’t incorporate do.
Income earned by a corporation is taxed at corporate tax rates – if it is left in the corporation. If someone is going to need all their corporate income personally, and will pull out all their profits, the tax savings ability of a corporation may not apply.
There may still be other reasons to incorporate, like mitigating liability or to take on partners, but it’s not to say you can’t just have sufficient insurance coverage or set up an unincorporated partnership to accomplish these goals.
That said, we’re already late in the year. And a handyman business may take a while to get off the ground. Income may not start to come in right away and business expenses are tax deductible against business income. Your start-up costs may offset some or all of your income for 2018. So, it may be your profit from this new business venture is modest initially, and particularly for the balance of this calendar year.
In 2019, if your handyman income may be your only source of income and you may need all the earnings personally to cover your living expenses, the corporation won’t provide any tax savings if you’re withdrawing all the profit.
Or if this business is a stop-gap while you look for a new job, it may be that the longevity of the handyman business is quite short.
A corporation will cost $1,500 or possibly much more with a lawyer to establish depending on where you live and certain other factors, Greg. Annual bookkeeping and corporate tax returns will cost $1,500 or more as well depending on the complexity of your business and the size of the accounting firm you use. If there is not a non-tax reason to set up the corporation, you may need well over $1,500 of annual ongoing tax savings to even break even financially.
Corporate tax rates on small business income range from 10% to 18% across Canada, averaging 13% for 2018. Compared to top personal tax rates of 45-54%, corporations can provide some serious tax savings.
The problem is justifying the initial and ongoing cost of incorporation, Greg. You may end up regretting the corporation when you may not make much additional income in 2018. And even if you did, you may be able to mitigate some of the tax by making an RRSP contribution and claiming a tax deduction against your income.
And even if you could leave money in the corporation in 2019 and future years, RRSP contributions, TFSA contributions and other opportunities may be better saving options than leaving profit in the corporation.
Incorporation has some great tax and non-tax benefits for the right business in the right circumstances. But it also has some significant and possibly unnecessary legal and accounting costs for the unsuspecting business owner.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.
