The late, great Benjamin Franklin is often credited with coming up with the statement that the only certainties in life are death and taxes. While it may or may not be verifiable that this phrase originated with him, one thing that definitely remains is the truthfulness of that statement. Very few things in life can be relied on more than the fact that everyone pays taxes and everyone dies (at least the last time we checked, this was still true). As Canadians, we often feel like we are paying way more taxes than is fair, and this rings doubly true for business owners who must pay taxes at multiple levels. It is this multiple taxation that makes it so that many business owners are looking for ways to minimize the amount of tax that they pay. It was this concept that made me think that talking to business owners about tax efficiency is always a good idea. To get this out of the way right up front, we aren’t about to point out a bunch of ‘loopholes’ to you on how to avoid paying taxes. Instead, we thought that it might help to point out some legal, effective ways for Canadian business owners to maximize their tax efficiency and minimize the tax burden that they face.
In This Article
- The Key to It All
- More Benefits of Incorporation
- Have You Thought About Your Healthcare Expenses?
- Avoid the Passive Income Trap
- Take Advantage of Your Advisory Team
The Key to It All
For so many of the tax planning and financial planning opportunities available to business owners, there is one key item that needs to be in place. Your business needs to be incorporated to take advantage of many of the planning opportunities for you. One of the most significant tax benefits of incorporating your business is that it may allow you to access the Small Business Deduction (SBD), which can reduce the corporate tax rate on eligible active business profits. If your business is incorporated and located in Ontario, you pay the combined federal and provincial corporate tax rate of 12.2% on the first $500,000 of net active business profit you generate each year. How important is this? Let’s do a quick comparison on a business that generates $350,000 in active profit (please keep in mind that for all of the examples I provide here, this is for general information. If you need specifics, try calling the team at Strata Accounting for expert advice). One business operates as a sole proprietorship; the other is a corporation. In both cases, we will assume that the business owner only requires $100,000 (pre-tax) a year in income to support their personal life.
- For the Sole Proprietorship, the $350,000 of profit is all treated as personal income, so your income tax bill if you earned this in 2025 is $143,458.
- Now look at a Corporation with the same amount of active business profit. The tax bill on $350,000 of profit corporately is around $42,700. This leaves $307,300 in the corporation.
- Now, if you withdraw the $100,000 you need personally (fully as salary), you would owe $21,719 in income taxes on that amount.
- Combined, this makes the tax that you pay $64,419. A difference of $79,039 compared to what you would have paid in total tax if your business was a sole proprietorship.
- In reality, the difference could be larger because of what you pay yourself. If paid as a salary, your earnings are a deductible business expense, which lowers your corporate taxes even more.
The bottom line is that you have no control over taxation when you are in a sole proprietorship. You pay tax on all of the money you earn in the year you earn it as a sole proprietor, even if you earn more than you need. If you are incorporated, you control the flow of money out of the corporation so you can minimize taxes by drawing only what you need out of the corporation.
More Benefits of Incorporation
Along with the ability to control how much money flows out of the corporation to minimize taxes, you can also control how that money flows out of the corporation. What this means is you decide if you want to pay yourself in the form of salary, dividends, or a combination of both. Since salary and dividends from Canadian-controlled corporations are treated differently for income tax purposes, you are again able to minimize the personal tax you pay. Let’s look at the differences and the pros and cons of paying yourself each way.
| Compensation Type | Pros | Cons |
| Salary (Bonus) | * Counts as an expense for the business (lowers corporate tax). * Creates RRSP contribution room. * Qualifies you for the Canada Pension Plan (CPP). | * Subject to immediate personal income tax withholding. * Subject to CPP contributions from both the employer and the employee |
| Dividends | * Not subject to CPP contributions (saves money upfront). * Taxed at a lower personal rate due to the Dividend Tax Credit. | * Paid out of after-tax corporate profit. * Does not create RRSP contribution room. * Does not count towards CPP when your retirement benefit is calculated. |
What does all of this mean? The result should come down to a discussion with your team of professional advisors, including your financial advisor and accountant. The way to pay the least tax every year is typically going to be paying yourself in the form of dividends. The major con to this is that dividend income doesn’t accrue you any RRSP room or any service time in the Canada Pension Plan. This can have a major impact on your retirement plan. In many cases, there is a mixture of the two types of income that will provide you with the most desirable outcome of CPP, RRSP room, and current taxes. Your journey to finding this mix will be made much easier by involving your financial and tax advisors.
Have You Thought About Your Healthcare Expenses?
Another advantage to running an incorporated business is the ability to set up a Healthcare Spending Account (HSA). An HSA is a Canada Revenue-approved plan that allows incorporated business owners to allocate a fixed amount of funds to be used to reimburse eligible medical expenses. When we talk to incorporated professionals about healthcare-related costs, we really like to highlight tax efficiency. An HSA works like this:
- You pay for an eligible medical or dental expense.
- You submit the claim to the HSA provider.
- Your corporate bank account has the amount of the expense plus an admin fee and applicable sales taxes applied withdrawn from it.
- The amount of the expense is reimbursed to your personal bank account.
The thing that makes this so tax-efficient is that the full amount of the claim, administration fee, and taxes are fully tax-deductible business expenses as a healthcare premium, just like paying a bonus to yourself would be. The real difference maker is that the money reimbursed into your personal bank account is not taxable income for you. When it comes down to the expenses you incur for healthcare and dental care, they need to be paid one way or another. One option is to draw more income from your company, and in turn pay more income taxes. The second option is to have the amount of the expense reimbursed to you without triggering any additional personal income tax. If you have questions about this type of plan and how you can get your business to help fund your healthcare-related expenses, the team at Strata Wellness & Benefits can walk you through why everyone who owns a corporation should have a healthcare spending account available to them.
Avoid the Passive Income Trap
Everyone loves the idea of ‘making their money work for them’. This means that you invest your money and it earns you income without you needing to ‘do’ anything. This passive income can be something as simple as the interest you earn on a savings account or rent paid to you on properties you own. When you have money in your corporation, you need to be wary of passive income, though, because if you earn too much of it, you can impact your tax situation. Remember, small businesses in Canada are eligible for the Small Business Deduction (SBD), which is a tax credit that reduces the federal tax rate from 15% to 9% on up to $500,000 of net active business profit. If you earn passive income in your corporation, you need to be careful because this can cost you the SBD. If you earn more than $50,000 in passive income, you reduce your $500,000 active business limit by $5 for every one dollar of that income, so if you make $150,000 in passive income, you lose the SBD completely. There are ways to avoid losing your Small Business Deduction that you can review with your advisors. They can include:
- Paying more out in salary and dividends.
- Setting up an Individual Pension Plan to funnel excess cash into a registered pension plan where it doesn’t accrue tax liability.
- Setting up corporately owned life insurance; the premiums fund the growth of the death benefit and cash value that generally won’t affect your passive income limit.
These are all strategies that can help you minimize your passive income without losing out on the value associated with the money held in your corporation.
Take Advantage of Your Advisory Team
The final note that I am going to make here is that you need to remember that Canadian tax rules are complicated and there’s not really a one-size-fits-all approach to what the best plan is for every business. The final concept is really simple but still bears pointing out. Your financial advisor, tax advisor, and legal team should all work together to help you build a plan to maximize the tax efficiency of your business. They can help you with many things, some complex and some simple, but they all require planning. All of these professionals must work together for you to make sure that you are maximizing your business’s tax efficiency. If you would like to talk to a team of experts that know the value of working together, try reaching out to Strata Wealth and Risk Management and Strata Accounting. They will be valuable members of your team!
