Choosing between incorporation and self-employment is one of the most important financial decisions for Canadian business owners. The structure you select affects how much tax you pay, how income is reported, your personal liability, and your long-term planning options. For businesses operating in Toronto and across Canada, understanding these differences is essential before tax season begins.

This guide explains the tax impact of being incorporated versus self-employed in Canada, with practical examples to help you make an informed decision.

Understanding the Difference Between Incorporated and Self-Employed

In Canada, most small business owners start as self-employed because it is simple and inexpensive. As revenue grows, incorporation often becomes an option worth considering. While both structures are legal and commonly used, they are taxed very differently.

The right choice depends on income level, risk exposure, future growth plans, and how much money you plan to withdraw from the business each year.

What Does It Mean to Be Self-Employed in Canada?

A self-employed individual usually operates as a sole proprietor. There is no legal separation between the business and the owner.

How Self-Employment Income Is Taxed

All business income is reported on the owner’s personal T1 tax return. The profit is added to other personal income and taxed at personal marginal tax rates.

This means:

  • Higher income can push you into higher tax brackets
  • There is no ability to defer taxes by leaving money in the business

Personal Liability

As a self-employed individual, you are personally responsible for all business debts and legal claims. Personal assets may be at risk if the business faces financial or legal issues.

Reporting Requirements

Self-employment works well for low-risk businesses with modest income, especially in early stages.

What Does It Mean to Be Incorporated in Canada?

An incorporated business is a separate legal entity. The corporation earns income, pays tax, and can enter contracts independently of the owner.

Corporate Tax Rates in Canada

Canadian-controlled private corporations (CCPCs) benefit from the small business tax rate, which is significantly lower than personal tax rates.

This allows:

  • Tax deferral by retaining profits inside the corporation
  • More flexibility in how and when income is paid to the owner

Separate Legal Entity & Liability Protection

Incorporation generally limits personal liability. The corporation is responsible for its debts, not the individual (with some exceptions).

Reporting Requirements

  • T2 corporate tax return
  • Separate bookkeeping and financial statements
  • Payroll filings if salary is paid

Tax Rate Comparison: Incorporated vs Self-Employed

Self-Employed Tax Rates

Self-employed income is taxed at personal marginal rates, which can exceed 50% at higher income levels in Ontario.

Corporate Tax Rates

Small business corporate tax rates are much lower. This creates a tax deferral advantage if profits are not immediately withdrawn.

Example: $100,000 Business Income

  • Self-employed: Entire amount taxed personally in the year earned
  • Incorporated: Corporation pays lower tax; owner pays personal tax only on salary or dividends taken

This difference is one of the main reasons growing businesses consider incorporation.

Business Expense Deductions: What Can You Claim?

Expenses for Self-Employed Individuals

Self-employed business owners can deduct reasonable expenses, including:

  • Office rent
  • Supplies
  • Marketing and advertising
  • Vehicle and home office (with limits)

However, CRA scrutiny is often higher for personal expense allocations.

Expenses for Corporations

Corporations can deduct similar expenses, but record-keeping tends to be cleaner due to separate bank accounts and financial statements.

Incorporated businesses often find it easier to justify expenses during CRA reviews.

CPP Contributions: A Key Difference

CPP for Self-Employed Individuals

Self-employed individuals must pay both the employee and employer portion of CPP. This can significantly increase annual tax costs.

CPP for Incorporated Business Owners

  • If paid by salary, CPP applies (split between corporation and owner)
  • If paid by dividends, no CPP is required

This flexibility allows better long-term planning depending on retirement goals.

Income Splitting & Tax Planning Opportunities

Self-Employed Limitations

Income splitting options are limited. Business income is taxed entirely in the owner’s hands.

Incorporated Advantages

Corporations may allow:

  • Salary or dividend planning
  • Income timing strategies
  • Retaining earnings for future use

These tools make incorporation attractive for tax planning beyond basic compliance.

Liability, Legal Protection & Risk Exposure

Self-employed individuals face unlimited personal liability. This is a serious concern for businesses with:

  • Employees
  • Contracts
  • Professional risk
  • Physical locations

Incorporation offers an added layer of protection and is often preferred in higher-risk industries.

When Does Incorporation Make Sense in Canada?

Incorporation may be worth considering when:

  • Annual profits consistently exceed a certain threshold
  • You do not need to withdraw all earnings each year
  • The business is growing or hiring employees
  • Liability risk is increasing

For many Toronto-based businesses, incorporation becomes attractive once the business matures beyond the startup phase.

Which Option Is Better for Toronto-Based Businesses?

There is no universal answer. Some businesses benefit from staying self-employed for years, while others should incorporate early.

Working with a professional firm like GTA Accounting can help business owners assess their specific tax position, future plans, and compliance obligations before making this decision.

Frequently Asked Questions

Is incorporation mandatory in Canada?

No. Most small businesses are not required to incorporate unless operating in specific regulated industries.

Can I switch from self-employed to incorporated later?

Yes. Many businesses start as sole proprietors and incorporate later when it makes financial sense.

Does incorporation reduce taxes immediately?

Not always. Tax savings depend on how much income is retained in the corporation versus withdrawn personally.

What are the annual costs of incorporation?

Costs include corporate tax filing, bookkeeping, and legal compliance, which are higher than self-employment.

Get Professional Advice Before Choosing Your Business Structure

Choosing between incorporation and self-employment is not just a tax decision. It affects cash flow, liability, compliance, and long-term planning. Before making a decision, it is important to review your numbers and future goals carefully.

A professional advisor can help evaluate whether incorporation will actually benefit your situation. Firms like GTA Accounting work with Toronto-based businesses to provide clear, practical guidance tailored to Canadian tax rules.