Should You Incorporate Your Small Business in Canada? Pros, Cons & Tax Implications

Should You Incorporate Your Small Business in Canada? Pros, Cons & Tax Implications (2025 Guide)

If you’re running a growing business in Canada, one of the biggest decisions you’ll face is whether to incorporate. Incorporation can offer major tax savings, limited liability, and a professional image, but it also comes with added costs and responsibilities. Understanding the pros, cons, tax implications, and your options for federal vs. provincial incorporation is key to making the right decision.

At Track Accounting Inc., we help entrepreneurs decide whether incorporation is right for them. Here’s a complete guide to help you understand how incorporation works, including tax savings, the Small Business Deduction, and what to consider when registering your company.

1. What Does It Mean to Incorporate a Business?

When you incorporate, your business becomes a separate legal entity from you personally. This means:

The corporation can own property, sign contracts, and incur debt.

Shareholders (owners) have limited liability—personal assets are protected from most business debts and lawsuits.

You must maintain proper corporate records and file annual corporate tax returns.

In contrast, operating as a sole proprietor means you and your business are the same legal entity—leaving you personally responsible for debts and taxes.

2. Pros of Incorporating a Small Business

Tax Savings through Lower Corporate Tax Rates: The first $500,000 of active business income is eligible for the Small Business Deduction, taxed at around 12–15% (varies by province) versus personal rates up to 53% in some provinces.

Tax Deferral: You can leave profits inside the corporation, paying only the lower corporate tax rate until you withdraw the funds later.

Limited Liability: Protects your personal assets from most business liabilities.

Professional Image: Clients often view incorporated businesses as more stable and credible.

Income Splitting (Limited): In some cases, you can pay dividends to family members (spouse or adult children) if they are actively involved in the business.

Access to Capital: Incorporated companies can raise funds by issuing shares.

3. Cons of Incorporating a Small Business

Setup and Maintenance Costs: Incorporation fees (federal or provincial), annual returns, minute book maintenance, and corporate tax filings all add costs.

More Paperwork: Corporations must file a separate corporate tax return (T2), keep financial statements, and maintain records.

No Automatic Access to Funds: You can’t freely withdraw money; you must pay yourself via salary or dividends.

Tax Complexity: You’ll need professional accounting to handle filings and optimize tax savings.

4. Federal Incorporation vs. Provincial Incorporation

In Canada, you can incorporate either federally or provincially. Here’s the difference:

Federal Incorporation

Gives your corporation the right to operate under the same name across Canada.

Costs slightly more to set up but offers broader name protection.

Must also register extra-provincially in the province(s) where you do business.

Provincial Incorporation

Incorporates only within a single province (e.g., Ontario).

Cheaper and simpler if your business operates primarily in one province.

If you expand to another province later, you’ll need to register there separately.

5. Naming Options: Custom Name vs. Numbered Corporation

When incorporating, you can choose between:

Custom Name Corporation: - Lets you create a unique brand name (e.g., “BlueSky Consulting Inc.”). - Requires a name search (NUANS report) to ensure no conflicts. - More professional and recognizable for marketing.

Numbered Corporation: - Assigned by the government (e.g., “12345678 Ontario Inc.”). - Cheaper and faster to register. - You can still use a “doing business as” (DBA) trade name for branding.

6. Corporate Tax Rates and Small Business Deduction

One of the biggest benefits of incorporating is access to lower corporate tax rates:

The first $500,000 of active business income is taxed at the small business rate (around 12–15% total, depending on the province).

Any income above $500,000 is taxed at the general corporate rate (around 26–31%, depending on the province).

You only pay personal tax when you withdraw money as salary or dividends, allowing for tax deferral and planning.