In this second post of the series, I will address another reason why you should incorporate your business; taking advantage of low corporate tax rates to significantly boost your retirement savings.
Corporate taxes on business income below $500,000 are currently at historical low rates of 15% in Ontario (federal and provincial combined). Thanks to recent announcements from the Federal Government, they will be dropping to 13.5% by 2018. As discussed in other posts, when you take funds out of your corporation, you will be taxed at higher personal tax rates, but if you don’t currently need the funds, then this can be a great strategy to defer taxes, and increase the amount you have available to invest.
How does it work?
Let’s say you have a business that is generating $150,000 in profits before any compensation being paid to yourself, but you only need $100,000 of that amount to cover your personal needs. If the business is unincorporated, you will pay personal income taxes for the year on the total $150,000 of income. If however the business is incorporated, you could retain the last $50,000 of profits in the corporation, and pay personal taxes only on the $100,000 of compensation that you withdraw.
In the unincorporated scenario, you will pay approximately $22,000 in personal taxes on that last $50,000 of income, leaving you $28,000 to invest for your retirement. If however the $50,000 was left in a corporation, you would pay only about $7,000 in corporate taxes on this amount, leaving you $43,000 to invest – over 50% more!
Impact of new tax proposals
The new tax proposals that I talked about in my last blog will indeed restrict the ability of this type of planning on a larger scale. Assuming the proposals are enacted substantially as is, if you earn more than $50,000 of investment income annually within a corporation, the taxation of these earnings will be very punitive.
In their press release, the Department of Finance said the rationale for the $50,000 exemption was based on a notional $1,000,000 of investments earning a 5% return. Although we still need to wait for the technical details of the new proposals, in theory through a combination of investments in growth and income generating stocks, it should be possible to manage the taxable portion of income earned on a portfolio significantly greater than $1,000,000 and still stay within the $50,000 threshold.
Personally, I do not think that the new measures relating to investment income earned within a corporation make sense, and at the very least they will be very difficult to administer. I do however applaud the addition of the $50,000 exemption, as this will definitely mean that many Canadians can still use this strategy in as a viable component of their overall retirement planning,