Should you incorporate?

The small business tax rate is dramatically lower than a personal marginal rate, which makes incorporating look like an obvious win. It is a deferral rather than a discount, and the distinction decides whether it is worth doing at all.

Where the advantage comes from

Active business income inside a Canadian-controlled private corporation is taxed at the small business rate — around 12.2% in Ontario — on the first $500,000 of income. Above that limit the general rate applies, around 26.5%.

So the benefit is not a lower total rate. It is that the money left inside compounds on a much larger base for as long as it stays there. The gap between the corporate rate and a personal rate is invested rather than remitted, and that head start is real.

Which makes the key question about cash flow

Someone who needs every dollar the business earns in order to live gets almost nothing from incorporating. The money passes through the corporation, is taxed on the way out, and ends up in roughly the same place — while the accounting and filing costs remain.

Someone who consistently earns more than they spend gets the full effect. The surplus stays inside at the corporate rate and grows, and the eventual personal tax is deferred until it is drawn — potentially decades later, at a lower personal rate.

The costs

• Incorporation and annual filing fees, plus a corporate tax return every year — a recurring cost measured in thousands rather than hundreds.
• Separate books, a separate bank account, and payroll administration if a salary is paid.
• Real complexity: the passive income grind, the dividend pools, TOSI, and the estate consequences — each of which is its own episode in this series for a reason.
• The personal services business risk for anyone whose corporation has essentially one client and looks like employment, which removes the small business rate entirely.

Sam’s deferral, compounded

Sam — 41, British Columbia, self-employed through a corporation. No employer pension, no home yet, and a company that pays them both salary and dividends.

Sam’s corporation earns $210,000 a year and pays them $105,000 in salary and dividends. The surplus stays inside, taxed at the corporate rate rather than Sam’s personal one, and invested.

The corporation is worth $401,179 today and $2,678,188 by 60 in today’s dollars. That growth is the deferral doing its work — money that would have been personally taxed on the way to a personal account, compounding inside instead.

The second bar is not a windfall. Every dollar of it still owes personal tax when it leaves the corporation, and the estate consequences of it never leaving are their own episode. What the deferral bought was decades of growth on the pre-tax amount rather than the after-tax one.

The other reasons, which are not tax

Limited liability, credibility with certain clients, and the eventual ability to sell shares rather than assets — with the lifetime capital gains exemption attached, which is a later episode. Those can matter more than the deferral, and they apply regardless of whether the cash-flow test above is passed.

Next: salary versus dividends, and what each one actually buys.

GlidePathEngine is an educational planning tool — not financial, investment, tax, or legal advice.