TAX DEFERRAL: Advantages of Incorporation
Contact Neufeld Legal for your incorporation legal work at 403-400-4092 / 905-616-8864 or Chris@NeufeldLegal.com
Tax deferral is a critical advantages available to business conducted through a corporation, primarily related to cash flow and the power of compounding on retained earnings.
A. Increased Cash Flow and Liquidity
By deferring the payment of taxes, the corporation keeps more of its profits available for immediate use.
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More Funds for Reinvestment: The money that would have been paid to the government today remains in the business. This provides a larger pool of capital to invest in operations, expansion, research and development, marketing, or new equipment. This reinvestment is critical for business growth.
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Enhanced Financial Flexibility: Increased cash flow allows the corporation to manage its working capital more effectively, handle unexpected expenses, or seize sudden business opportunities without having to seek external financing immediately.
B. The Power of Compounding on Tax-Deferred Income
This is arguably the most powerful long-term advantage.
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Greater Investment Base: The deferred tax amount is retained and invested, meaning a larger principal is working for the corporation. When this larger principal earns a return (e.g., interest, dividends, or capital gains), the return itself is larger.
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Tax-Deferred Growth: The earnings on that larger principal also compound on a tax-deferred basis until the funds are ultimately paid out to the shareholders (when personal tax is paid). Over many years, the difference between a tax-deferred investment and a fully taxed investment can be immense, leading to substantially greater wealth accumulation within the corporation.
C. Utilizing Lower Corporate Tax Rates (The Deferral Mechanism)
In many jurisdictions, corporate tax rates on active business income (especially for small businesses) are significantly lower than the top personal marginal income tax rates [more on tax rates].
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Delaying the Higher Personal Tax: A corporation can pay tax on its income at the lower corporate rate. The owner must pay the higher personal income tax only when those funds are withdrawn from the corporation (e.g., as a salary or dividend).
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The Deferral: By retaining earnings, the business owner effectively defers paying the difference between the low corporate tax and the high personal tax. This "tax gap" is the source of the financial advantage that can be invested for growth.
D. Strategic Timing for Withdrawals
Tax deferral provides business owners with control over when they incur their personal tax liability.
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Tax Rate Optimization: The owner can choose to pay out a dividend or salary in a future year when their personal income is lower (e.g., during retirement, a sabbatical, or a year with business losses). This allows the owner to be taxed at a lower personal marginal tax rate, potentially reducing their overall lifetime tax burden.
So if you are looking to incorporate a new corporation or deal with the corporate legalities impacting your company, contact our law firm to schedule a confidential consultation with a lawyer experienced in the legal intricacies of business incorporation and commercial business development at 403-400-4092 [Alberta], 905-616-8864 [Ontario] or via email at Chris@NeufeldLegal.com.
