When should you incorporate your side hustle?

Incorporating does not lower your tax bill on money you spend. It lowers the tax on money you leave in the company. That distinction is the whole decision.

What a corporation actually buys you

Active business income up to $500,000 is taxed at the small-business rate — roughly 12.2% combined in Ontario, and between 9% and 12% in most provinces. A sole proprietor earning the same profit pays personal rates, which reach into the forties well before $200,000.

But the moment you pay yourself, personal tax applies. Take every dollar out and you land in roughly the same place as a sole proprietor, having paid several thousand dollars for the privilege.

The test to apply

1. Work out your profit after every legitimate expense.
2. Subtract what you need to live on. What is left is retained earnings.
3. Compare the tax deferral on that retained amount against $3,000 to $5,000 of annual cost.

As a rough guide, incorporation starts paying when you can retain $40,000 or more a year. Below that, the compliance cost usually eats the benefit.

The reasons that are not about tax

• Liability. A corporation is a separate legal person, which matters if you carry real operational risk.
• Clients. Some enterprise and government buyers will not contract with a sole proprietor.
• Income smoothing. A corporation lets you pay yourself evenly across a lumpy year, which lowers lifetime tax.
• Succession. Shares can be sold or transferred; a sole proprietorship largely cannot.

Salary or dividends

Salary is deductible to the company, creates RRSP room and CPP credits, and requires payroll remittances. Dividends skip CPP — saving 11.9% — but give up the RRSP room and the future CPP benefit that came with it. Most owner-managers use a blend, set annually with an accountant.