If you have an incorporated business, there are a number of things to keep in mind. A corporation is a separate legal entity from the shareholder who owns it. It is also taxed separately, meaning that the shareholder must be aware of tax consequences any time they draw money from the company or have the company pay for something that is actually a personal or non-business expense. Drawings from the company are a dividend or salary unless it is a repayment of a loan given to the company in the past. Having the company buy back the shares from the shareholder is also a deemed dividend for tax purposes. Tax rules are especially harsh if the company pays for something that is actually for the shareholder’s own use (essentially double tax). It is important to keep a very clear distinction between what is owned and used by the business and what is personal.
There are still a few perks to being incorporated. One is that there is some liability protection between the company and the shareholder. The second is being able to defer income in the company. The company earnings are taxed a lot lower than personal earnings, so if those earnings are kept in the company as money that can be invested or available for future business needs, it can be quite tax effective. A third perk is that it allows personal income to be smoothed out. A shareholder can continue to take out the same salary or dividends yearly even if the business does really well one year or not so well in another whereas a sole proprietor or partner in a partnership would have to realize all the income personally in the year it was made. Lastly, a company can have Health Spending Accounts and some group benefits even if there is only one other employee other than the shareholder. It is a good way to have health care expenses paid with low-taxed company dollars instead of paying it personally.
Recent government changes to the income tax act have made it difficult to give any dividends out of the company to family members. Basically, the government wants to ensure that family members actually work for the money and don’t receive it just as a way to income split and use family members’ lower marginal tax brackets (refer to chart under Managing Taxable Income). Incorporated professionals like doctors and lawyers were hit especially hard with this new legislation. It used to be common practice to use a family trust and split dividends out to adult children and spouses. In conjunction with stopping income splitting, both the provincial and federal governments have been steadily raising tax on anyone making over $230,000 of taxable income. In contrast, the US allows couples to pool their income and file taxes jointly and the top tax bracket for that kind of arrangement doesn’t occur until they are over $612,000. There have been many groups raising concerns that Canada is not being competitive in attracting and growing business, but as of yet, the government is maintaining its course of taxing people as individuals and restricting income splitting.