Are you incorporated?
What to consider about saving to a TFSA versus a corporation
A common question faced by incorporated business owners is whether to save to a Tax-Free Savings Account (TFSA) or to a corporation. Here is a summary of each:
The TFSA is a unique registered savings vehicle that allows for tax-free growth and withdrawals of invested capital and associated income. However, for incorporated business owners, having the funds to contribute to a TFSA will often come at a cost of upfront personal tax as dividends need to be paid out from their corporations, which otherwise could have been retained and invested within the corporation.
The TFSA was introduced in 2009 as a registered savings vehicle providing a limited amount of contributions, with unused contribution room being available to carry forward. Only individuals can fund a TFSA, and while contributions are not tax-deductible, investment income and gains realized in the account, as well as withdrawals, are tax-free. Furthermore, withdrawals from a TFSA can be recontributed in the following calendar year.
For Canadian residents, TFSA contribution room accumulates annually by a dollar limit, allowing for additional savings. The TFSA dollar limit for 2023 is $6,500. For individuals who were at least age 18 in 2009, have always been resident in Canada, and have never contributed to the TFSA, the cumulative contribution room in 2023 is $88,000.
More information on the TFSA is available in our “Tax-Free Savings Account” education article. Please contact our team for a copy.
Canadian business owners commonly set up private corporations, referred to as Canadian-controlled private corporations (CCPC), because they can provide a significant tax deferral advantage on active business income carried on in Canada, compared to earning the same income personally.
Business income: In almost all provinces (excluding Saskatchewan), the first $500,000 of active business income is eligible for a “small business deduction” that reduces the combined federal and provincial corporate tax rate on such income to between approximately 9% and 14%, depending on the province. Active business income above the small business deduction limit is taxed at the regular general corporate rate, ranging between approximately 23% and 31%, depending on the province.
Investment income: While active business income in a CCPC obtains favorable tax rates, investment income is subject to an upfront higher rate of tax, a portion of which is refundable once taxable dividends are paid out to the CCPC’s shareholders. This additional refundable tax recognizes that CCPC owners can save more capital in their corporations to invest in passive assets compared to unincorporated individuals, and encourages the regular distribution of taxable dividends.
Factors to consider
When does it make sense for you as a business owner to withdraw additional dividends in excess of lifestyle requirements to contribute to your TFSA? The results will vary depending on several factors, including:
- The type of investment income earned in the TFSA or the corporate portfolio;
- The rate of return generated on the investments;
- The investment horizon;
- The province of taxation of the CCPC and the business owner; and
- The personal tax rates applicable.
The funding of TFSAs for many incorporated business owners is dependent on how much you withdraw as dividends from your private corporation. There is significant personal tax deferral achieved if funds are retained in the corporation. However, there may still be advantages to paying out additional taxable dividends in order to maximize TFSA contributions.
Talk to us for further information, including access to a detailed article prepared by our Tax & Estate Planning Team.