Is it worth incorporating to avoid CPP (To reinvest in your business)?
I was challenged recently on the idea that perhaps it might make sense to avoid paying into CPP and using those funds to reinvest in the business. After all - when bootstrapping a startup - every dollar counts right?
I agree with the idea that every dollar does count...but I wanted to parse apart the numbers a bit more because I think this might actually be one of those that seems good on the surface but perhaps isn't as strong as we think when we pull apart the numbers.
If we use the estimated enhancement for 2025 as future starting point: The "estimated" amount is $8,488. (https://www.advisor.ca/practice/planning-and-advice/should-business-owners-avoid-cpp-by-paying-themselves-dividends/)
Using this estimated amount - at the highest tax bracket - a Business owner would retain only about $6,000 in the corporation if they were to pay themselves as dividends.
At lower tax brackets - because the CPP deduction component has a lower value to the marginal tax rate - there would be higher amounts left in the corporation. As a result we can use a range of $6,000 - $7,000 as a range for what is left in the corporation when accounting for the credits & deductions.
$6,000 - $7,000 depending on the stage the business is in can be a lot of money. But that's not what a business owner ACTUALLY gets to keep.
If the sole purpose of incorporating was to be able to avoid CPP - then we need to tie the costs of incorporation to this as well. If we use $3,000 as the cost to incorporate in year 1 and then each year after $1,500 for tax filings for the corporation then really we are only looking at $3,000 - $4,000 in the first year of savings to reinvest back into the business and $4,500 - $5,500 in subsequent years.
Base line assumption: $4000-$5000 annually in the corporation in the first few years.
Key takeaway 1: There is "some" financial benefit to incorporating to avoid CPP. I want to acknowledge that.
Key Takeaway 2: This is inside the corporation as a reminder. To get this money out we need to pay a dividend and incur extra tax and that closes the delta even more. So this only works if you keep the money in the corporation. If you pay it all out...you are making an expensive mistake once we factor the cost of your corporation filing in there.
Key Takeaway 3: Is $4,000-$5,000 worth it? Will it truly help your business?
3A) I can't answer that for everyone but if you are looking at entering a business that is so tight (and your personal savings is so lean) that $4,000 - $5,000 is the difference between your business surviving or going under...should you rethink your entry into this business? (We are talking about the early days of a business start up so theoretically you've done some type of market research).
Recommended by LinkedIn
3B) Could economics change? Ex. Covid? Sure. Maybe you had a business idea that would have worked and then things all of a sudden pulled a 180 on you. If so...then maybe this is a temporary stop gap. However I would argue that this is far more an edge case or "extraordinary" circumstances than common knowledge.
Dividend Gross up & Canada Child Benefit (and other benefits)
There is also another challenge. If your business is truly in that early days start up phase...then you are probably not taking a lot of money for personal income. If you are living very modestly then if you have kids you are likely qualifying for Canada Child Benefit (and perhaps other income tested benefits).
The Dividend Gross Up means that you will show a personal income of thousands more vs if you took your income as Salary. If you have a child or children - then you will lose hundreds of dollars off your Canada Child Benefit. If you are truly living lean then it could potentially be even almost a thousand dollars when we factor other income tested benefits for middle to lower income households. This might not seem like a lot until we go back to the above and realize we just knocked a large chunk off our "money we were going to reinvest into the business". So we might only be looking at potentially $3,000 - $4,000.
What are we giving up?
If we assume that even if this is a tight business - it's one we want to take the risk on then we need to consider a few things.
1) This is a "risky" venture. If it wasn't that risky - a few thousand dollars shouldn't make or break the business to keep it going for a full year. If that's the case - relatively safe assets like CPP (An element of creditor protection as well as guaranteed income later on) take on more value when we consider them holistically.
2) The other elements of CPP become more important because this business owner theoretically doesn't have other savings. If they did - they could be using those to fund/bootstrap the business and let the CPP contributions ride. So in this case - the other elements like disability as well as survivor's / orphan's benefit take on disproportionate value.
3) Totally irrelevant for the present but if you are so adamant that this business is going to be a massive money maker...then you are giving up RRSP room. For successful business owners -that tax shelter becomes very valuable.
Bottom line...yes incorporation may save a few thousand dollars. That is true and I won't deny that. What I will say is the relative benefit is not as big as it's made out to be.
With that said...the type of business and the type of person/business who would benefit from only a few thousand in the corporation to keep it going is also the type of person/business who would benefit the most from CPP from a financial planning standpoint.
#Incorporation #personalfinance #Financialplanning #money #CPP #financialliteracy