Should You Incorporate?

A common question we get from clients is: “Should I incorporate?”
This comes up frequently for:

• Professionals – dentists, doctors, pharmacists, real estate agents, accountants, lawyers
• Small business owners

It’s a great question, and the right place to start is with the basics.

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What Is a Corporation?

A corporation (aka a company) is a separate legal entity: think of it as an “artificial person” with its own rights and responsibilities. Even if you are the sole shareholder and director, the company exists apart from you personally.

At its most basic level, you would incorporate to accomplish one (or both) of these objectives:

1. Tax Efficiency
2. Risk Mitigation

Let’s break these down.

Tax Efficiency

In Ontario, Canadian Controlled Private Corporations pay a much lower tax rate on the first $500,000 of active business income – currently around 12.2% - compared to the top personal marginal tax rate of over 53%.

This means you can leave excess profits in the corporation to defer personal taxes until you withdraw the funds later, potentially at a lower tax rate.

Example
Imagine your business earns $300,000 but you only need $150,000 for personal expenses this year. Instead of paying personal tax on the full $300,000, you can leave $150,000 inside the corporation, which is taxed at a lower rate, leaving you with more to invest and grow your wealth more efficiently.

Risk Mitigation

Because a corporation is a separate legal person, its liabilities are generally limited to its own assets. This means if the company is sued, your personal assets are generally protected.

Important note: Professionals operating through a professional corporation (like doctors, lawyers, accountants) are still personally responsible for professional negligence. But a corporation can still protect you from certain types of business risk, like lease obligations or supplier disputes.

Holding Companies for Wealth Management

For many of our clients, the real opportunity is in how a holding company can support their retirement and estate planning.

Retirement Planning

Your holding company can become a powerful retirement income tool. One of the greatest advantages of using a corporation is the flexibility to control when and how you withdraw income.

Rather than taking a salary, you can pay yourself dividends from your holding company. With the correct share structure in place, you may also be able to pay dividends to your spouse (or adult children) who are shareholders, giving you the ability to split income and take advantage of lower personal tax brackets.

Example: Income Splitting Through Dividends
Let’s say you and your spouse each own shares of your holding company and you need $120,000 to live on each year. Instead of one spouse taking the full $120,000 and paying tax at a higher rate, you could each take $60,000 in dividends, keeping you both in a lower tax bracket and reducing your combined tax bill.

Over time, this flexibility can save tens of thousands of dollars in taxes, helping your retirement funds last longer.

Individual Pension Plans (IPPs)

Another powerful strategy for incorporated professionals is an Individual Pension Plan (IPP), a defined benefit pension plan set up by your corporation for your benefit.

• Higher contributions: At higher income levels, you can contribute more than the RRSP limit.
• Tax-deductible contributions: The company gets a tax deduction for contributions.
• Creditor protection: Assets in an IPP are generally protected from creditors.
• Top-up contributions: If the plan’s investments underperform, the company can make additional tax-deductible contributions to ensure the promised pension is funded.

IPPs are an excellent way to extract funds from your company on a tax-deferred basis while building predictable retirement income.

Asset Transfer

A holding company can also simplify the transfer of assets – such as an investment portfolio, real estate, or shares of an operating business – to your beneficiaries. With the right planning, this can minimize probate fees, reduce double taxation, and create a smoother transition for your family.

Corporate-Owned Life Insurance

When a permanent life insurance policy is owned by your corporation, the company pays the premiums. Upon death, the insurance proceeds are paid to the corporation (mostly, if not entirely) tax-free. These proceeds are then credited to the company’s Capital Dividend Account (CDA), allowing your estate to pay out the death benefit to your heirs as a tax-free capital dividend.

This is a powerful way to replace the value of corporate assets that will be taxed on your death (such as investment portfolios or real estate), ensuring your heirs receive more of what you’ve worked hard to build.

Leveraged Life Insurance

Some clients worry that purchasing a permanent life insurance policy means tying up valuable corporate capital that could otherwise be used in the business. Leveraged life insurance addresses this concern.

Here’s how it works:

1. The corporation purchases a permanent life insurance policy and is named the beneficiary.
2. The policy is assigned as collateral for a line of credit with a lender.
3. The lender advances loan amounts to replenish the corporation’s working capital.
4. The corporation makes interest payments on the loan, which may be tax-deductible (consult your tax advisor).
5. Upon death of the insured, the life insurance proceeds are paid to the corporation.
6. The loan is repaid from the proceeds, and the remaining amount (less the adjusted cost base) is credited to the CDA, allowing a tax-free dividend to be paid to shareholders.

This strategy allows the corporation to maintain liquidity, preserve access to working capital, and still achieve a highly tax-efficient wealth transfer.

Final Thoughts

Incorporating isn’t right for everyone, and there are costs and compliance requirements to consider. The decision should be made with your corporate lawyer and tax advisor.

But when it’s appropriate, a corporation can be one of the most powerful tools for building, preserving, and transferring your wealth.

If you’d like to explore whether incorporation, a holding company, or a leveraged insurance strategy makes sense for your situation, let’s talk.