When to incorporate: the revenue and risk signals that make it worth it

The right time to incorporate is when the corporation will do something a sole proprietorship cannot: shelter profit you do not need to spend, sign a contract a client insists on, put a wall between the business and your house, or start the clock on a future tax-free sale. Reaching a particular revenue figure is not a trigger on its own. We see profitable consultants at $300,000 who should stay unincorporated for another year and founders at $60,000 who should have incorporated last quarter. Below is the framework we use in a discovery call, with the costs and the limits stated plainly.

Signal one: profit you do not need personally

The main tax reason to incorporate in Ontario is the gap between the small business rate and your personal rate. Active business income up to $500,000 in a Canadian-controlled private corporation is taxed at 12.2% combined federal and Ontario. The same dollar earned personally is taxed at your marginal rate, which passes 43% somewhere above $115,000 of income depending on the year's brackets, and reaches 53.53% at the top. The difference is a deferral, not a saving: when the money eventually comes out as a dividend, the total tax lands within about a percentage point of what you would have paid directly. The benefit is the years in between, during which the deferred tax works for you inside the company.

That benefit is exactly zero if you spend everything the business earns. So the first question is not revenue but surplus: after paying yourself what your household needs, is there money left over year after year? If the answer is $20,000 or more and rising, the deferral starts to outweigh the compliance cost. If the answer is nothing, incorporation is a cost centre until that changes. Our answer on how sole proprietorship and corporation taxes compare puts the rates side by side.

Illustrative example: a consultant clears $220,000 and needs $110,000 for living costs. Unincorporated, all $220,000 is taxed personally in the year. Incorporated, she draws $110,000 as salary, which the corporation deducts, and the remaining $110,000 is taxed at 12.2%, about $13,400. The personal tax that would have applied to that second $110,000 in Ontario falls somewhere in the mid-$40,000s to low $50,000s depending on the year's brackets. Roughly $35,000 more stays invested in the company that year, with tax due only when she takes it out.

Signal two: liability you cannot insure away

A corporation is a separate legal person. Its debts, leases and lawsuits are its own, and a creditor's claim stops at the company's assets unless you have signed personally. That protection matters most once you have employees, premises, product liability or contracts larger than your insurance. It has three well-known holes. Banks and landlords routinely ask the owner for a personal guarantee, which puts your house back on the table for that debt. Directors are personally liable for unremitted source deductions and HST, and for up to six months of unpaid employee wages. And no corporation shields a professional from liability for their own negligence, which is why a professional corporation protects a dentist's savings from a lease dispute but not from a malpractice claim. See who can have a professional corporation.

Signals three and four: someone requires it, or a sale is coming

A contract, a client, a hire or a partner

Some doors only open to corporations. Larger Canadian companies and most US clients prefer or require a corporate vendor, partly for their own misclassification protection. A US client will ask a Canadian corporation for a Form W-8BEN-E, and the Canada-US treaty keeps the income out of US tax as long as the corporation has no fixed place of business there. Hiring is possible as a sole proprietor, but an employment relationship, a payroll account and a WSIB registration sit more naturally inside an entity that will outlive the founder's involvement. Bringing in a partner is close to impossible without one: a corporation can issue shares in whatever proportions and classes the deal calls for, governed by a shareholders' agreement.

A sale on the horizon

The lifetime capital gains exemption shelters up to $1.25 million of gain on the sale of qualified small business corporation shares, per shareholder. It is available only for shares, only where the shares have been held by you or a related person for the 24 months before the sale, and only where the corporation's assets pass the active-business tests over that period. A sole proprietor selling assets gets none of it. If a sale is plausible within five years, incorporating now starts the holding period and leaves time to keep passive assets out of the company, which is the most common reason we see a sale fail the tests. The rules are set out in how to qualify for the lifetime capital gains exemption.

The costs and the admin, honestly

Government filing fees are modest: as at the time of writing, articles of incorporation cost $300 online in Ontario and $200 federally, plus a NUANS name search unless you take a numbered company. Legal and accounting fees for a proper set-up are the larger number, and we quote them after a discovery call. The recurring burden is what changes your routine:

• A T2 corporate return with financial statements every year, due six months after the year-end, with the balance owing due three months after year-end for most small corporations.
• A separate corporate bank account and bookkeeping that keeps the company's money apart from yours. Money you take without a salary or dividend is a shareholder loan, and a loan not repaid within one year after the end of the corporation's year in which you took it is added to your income.
• A T4 or T5 each February for whatever you paid yourself, and a payroll account if you choose salary. See salary or dividends from your corporation.
• An annual corporate return to the province or Corporations Canada, distinct from the tax return, and a minute book kept current.
• Two tax filings in the year you switch: a final T2125 on your personal return for the unincorporated months and a first T2 for the corporate ones.

Our incorporation and compliance service handles the set-up and the recurring filings as one engagement, and how much it costs to incorporate in Ontario breaks down the government fees. Whether to incorporate federally or provincially is a smaller decision than people expect; federal or Ontario incorporation covers it.

Timing the switch

Within the year

A sole proprietorship reports on the calendar year. A corporation chooses its own year-end, anywhere within 53 weeks of incorporation: a year-end shortly after your busiest season gives you the longest runway to plan. Incorporating in early January keeps the transition clean; incorporating in October because a contract demands it is fine too, since the split year is administrative rather than costly. What we advise against is incorporating in a loss year. A start-up loss earned personally offsets your salary or other income immediately; the same loss inside a corporation is trapped there until the company turns a profit. Founders who expect two years of losses, common among the start-ups and tech companies we work with, are often better off staying unincorporated until the business turns, then rolling it in. Our answer on choosing a fiscal year-end goes further.

Moving an existing business in: the section 85 rollover

Transferring a going business to a new corporation is a disposition, and goodwill, equipment and customer lists that have grown in value would ordinarily trigger tax on the transfer. Section 85 of the Income Tax Act lets you and the corporation jointly elect a transfer price anywhere between tax cost and fair market value, so the gain is deferred into the shares you receive. The election is filed on Form T2057 by the earlier of the two parties' filing deadlines, and a late election is penalised at up to $100 a month to a maximum of $8,000. Pair it with the GST/HST election on Form GST44 so no HST applies to the transfer of the business assets, and leave real estate out unless the land transfer tax has been costed. See what a section 85 rollover is.

What incorporation does not do

It does not turn an employee into a business

If you incorporate and then work for one client under their direction, with their equipment and hours, the CRA can treat your company as a personal services business. A PSB loses the small business deduction and the general rate reduction, pays about 44.5% combined in Ontario, and may deduct almost nothing except the salary it pays you. The test is whether you would be an employee without the corporation, and it is decided by the working relationship, not the paperwork. Our answer on avoiding personal services business status lists the facts that matter.

It does not let you split income freely

Since 2018 the tax on split income rules tax dividends paid to a spouse or adult child at the top rate unless an exclusion applies, such as a spouse who is 65 or older, a family member who works in the business an average of 20 hours a week, or one who holds 10% of the votes and value in a non-service business. Incorporating to sprinkle dividends across the family is no longer a plan on its own.

It does not replace insurance

Professional liability, general liability and cyber cover remain necessary. The corporation limits the reach of a judgment; it does not prevent one.

Our decision framework in one table

If three or more rows point toward incorporating, we usually say yes. Read should I incorporate my small business in Ontario for the short version, and if a second company is part of the conversation, holding company pros and cons covers that layer.

Sources: CRA — Corporation tax rates · CRA — Form T2057.