Incorporate or Not? Pros and Cons of Incorporating Your Business – A Complete Guide by a Montreal CPA Firm Near You

Deciding whether to incorporate your business in Canada is one of the most

consequential financial and tax decisions an entrepreneur can make. Incorporation

affects everything from tax rates and legal liability to financing opportunities, long-term

growth, and how much money you keep after taxes. Many business owners believe

incorporation automatically reduces tax, while others assume incorporation is

unnecessary unless the business is large. Both assumptions can be wrong.

Understanding whether to incorporate or not in Canada requires evaluating your income

level, business risks, industry, long-term plans, cash flow needs, and eligibility for small

business deductions. This guide explains the pros and cons of incorporation, the tax

implications, the legal protections, and when a sole proprietorship or partnership may

still be appropriate. With the right structure, business owners can significantly reduce

taxes and protect personal assets—without making costly mistakes.

Legal and Regulatory Framework

Incorporation in Canada is governed by both federal and provincial legislation. A

corporation can be formed federally under the Canada Business Corporations Act

(CBCA) or provincially (e.g., Québec Business Corporations Act). From a tax

perspective, corporations are governed by the Income Tax Act, which defines a

Canadian-Controlled Private Corporation (CCPC) under subsection 125(7). CCPCs are

eligible for the Small Business Deduction (SBD) on the first $500,000 of active

business income, dramatically reducing the corporate tax rate. Incorporated businesses

must file a T2 Corporate Income Tax Return, maintain separate accounting records,

follow shareholder rules, and comply with corporate governance obligations. Sole

proprietors report income on an individual T1 return under section 9 of the Act.

Understanding these rules is essential when deciding whether to incorporate or not in

Canada.

Key Court Decisions

Courts have clarified critical issues that influence incorporation decisions. In Neuman v.

Canada, the Supreme Court addressed dividend sprinkling and confirmed that

corporate structures cannot be used to circumvent the Income Tax Act’s attribution

rules. In McClarty v. Canada, the court emphasized the importance of corporate-level

documentation and legal separation between the owner and the corporation. In Brown v.

The Queen, the Tax Court highlighted that improperly structured corporations can lead

to personal liability if corporate formalities are ignored. These decisions illustrate that

incorporation offers significant advantages only when the structure is properly

implemented and maintained. When deciding whether to incorporate or not in Canada,

business owners must understand these risks and responsibilities.

Why CRA Targets This Issue

CRA closely reviews incorporation structures because many taxpayers misunderstand

the rules surrounding CCPC eligibility, shareholder loans, and income splitting. When

business owners incorporate without proper tax planning, CRA may reassess them for

issues such as unreasonable salaries, improper dividends, or personal expenses

charged through the corporation. CRA also examines whether income qualifies as

active business income eligible for the SBD or whether it should be classified as

passive or investment income. Businesses that are incorporated primarily for tax

avoidance without legitimate commercial purpose are also subject to CRA scrutiny.

Understanding the tax implications of incorporation helps prevent reassessments and

financial penalties.

Mackisen Strategy

At Mackisen CPA Montreal, we help entrepreneurs analyze whether incorporation is the

right choice based on income level, risk exposure, industry, and long-term goals. Our

assessment begins with calculating the tax difference between operating as a sole

proprietor versus a corporation. We determine whether the business retains profits

(making incorporation more beneficial) or distributes most income to the owner

(reducing corporate advantages). We then evaluate liability exposure, financing needs,

shareholder structure, payroll implications, and eligibility for the Small Business

Deduction. For businesses ready to incorporate, we structure corporate share classes,

set up payroll and dividend strategies, and ensure proper bookkeeping systems. For

those not ready, we create tax-efficient sole proprietorship plans that reduce risk while

preparing for future incorporation. Our structured approach ensures that business

owners understand the full tax and legal consequences when deciding whether to

incorporate or not in Canada.

Real Client Experience

A self-employed consultant earning $180,000 per year approached us wondering

whether incorporation would save tax. After analyzing cash flow, we determined the

client could leave a portion of income inside the corporation, allowing access to the

lower corporate tax rate. Incorporation saved them tens of thousands of dollars

annually. Another client earning $60,000 per year believed incorporation would lower

their tax bill. After review, we recommended staying as a sole proprietor because they

needed to withdraw all earnings to cover living expenses, eliminating the tax deferral

benefits of incorporation. In a third case, a construction contractor faced personal

liability risks. Incorporation provided legal protection and improved credibility with

clients. These examples illustrate why the decision to incorporate or not in Canada

depends on income, risk, and long-term planning.

Common Questions

Business owners often ask whether incorporating automatically reduces taxes. It does

not—tax savings depend on retained earnings and proper planning. Others ask whether

incorporation provides legal protection. Yes, when corporate formalities are followed.

Some ask whether they can pay themselves solely in dividends. While possible,

dividends may affect CPP contributions and personal benefits. Entrepreneurs also ask

whether incorporation helps with income splitting. Yes, but strict TOSI (Tax on Split

Income) rules apply. These questions highlight why understanding the pros and cons of

incorporation in Canada is essential.

Why Mackisen

With more than 35 years of combined CPA experience, Mackisen CPA Montreal helps

entrepreneurs choose the right business structure, minimize taxes, and protect their

future. Whether you are evaluating whether to incorporate or not in Canada,

restructuring an existing business, or planning for long-term growth, our expert team

ensures precision, transparency, and protection from audit risk.