Integration, incorporation and compensation planning: Navigating professional income and tax strategies

On $400,000 of business income as a sole proprietor, Martin will pay personal tax and CPP contributions on self-employment income totalling approximately $162,600 in Saskatchewan. 

If Martin was incorporated and paid himself wages from his company, he would need to pay wages of approximately $230,000 to have $150,000 remaining after paying $80,000 of income taxes and employee CPP contributions. 

His company would earn $400,000 and then deduct wage expenses of $234,000 (including employer CPP contributions) and other additional expenses for annual corporate filings estimated at $5,000. As a result, the annual taxable income in the company would be $161,000 (400,000, less 234,000, less 5,000). The corporate tax rate in Saskatchewan for ABI less than $500,000 is 10 percent. Therefore, the corporation would pay $16,100 in taxes and retain $144,900 ($161,000, less $16,100) to invest. 

When earning his $400,000 business income as an individual, paying taxes of $162,500, and personal expenses of $150,000, Martin has about $87,500 remaining to put toward savings and investments. This is $57,400 ($144,900, less $87,500) less than the corporation had to invest. The corporation has more available because it has deferred the personal tax on these earnings. 

Let’s assume a three percent after-tax rate of return on investments: If Martin invested the $144,900 after-tax corporate income annually, the total value of the investments in the company after 20 years would be approximately $3.88 million.

If Martin continues to operate as an individual, investing his after-tax income of $87,500 annually, the total value of his personal investments would be approximately $2.35 million. In 20 years, the company will have accumulated about $1.53 million ($3.88, less $2.35 million) of additional capital. However, to receive the $3.88 million from the company, Martin will still need to pay personal taxes for amounts received personally. 

Below, we will look at the tax implications of three scenarios for Martin withdrawing this capital in retirement.

Martin takes it out all at once

If Martin planned to pay the full $3.88 million out to himself all at once as a dividend, he would pay about $1.57 million in tax as a resident of Saskatchewan. This would leave him with about $2.31 million ($3.88 million, less $1.57 million) — which is 40,000 less than the $2.35 million he would have accumulated while earning his business income as a sole proprietor.

The main reason for this difference is that paying all the capital out in one year resulted in most of the dividend income being taxed in the highest personal tax bracket. The effective tax rate on the dividend income was 40.5 percent. As a result, the business income retained in the company was taxed at a combined rate (including both corporate and personal taxes) of about 46 percent. This is higher than Martin’s effective tax rate of about 40 percent on the business income he would have earned as a sole proprietor that was spaced evenly over 20 years. 

In general, the higher effective personal tax rate on the large dividend distribution and the additional annual costs of maintaining the company were only partially offset by the increased investment earnings on the company’s accumulated capital. Withdrawing all the capital in one year eliminated the 20 years of tax deferral benefits Martin had gained by using a professional corporation.

Martin continues to withdraw $150,000 in after-tax funds.

Instead of paying out the capital from his company all at once, if Martin continued to withdraw only what he needed to have $150,000 in after-tax funds each year during retirement, he would only need to pay himself annual dividends of about $201,500. On these dividends, he would pay taxes of about $51,500 as a resident of Saskatchewan. 

The effective tax rate on these dividends is approximately 25.6 percent. This is 15 percent less than the 40.5 percent effective rate he would pay by withdrawing all the capital in one year. In addition, continuing to earn investment income on the additional capital in the company while paying it out over many years creates a significant compounding effect on the investment earnings in the company.

At the time of his retirement, if Martin had operated as a sole proprietor, he would have accumulated about $2.35 million in personal after-tax investments. On the other hand, by operating through a professional corporation, he will have accumulated about $3.88 million of tax-deferred investments in the company.

Let’s assume that Martin and his professional corporation continue to earn a three percent after-tax rate of return on investment income during retirement. If Martin withdraws $150,000 from his sole proprietor investments each year, the investments last him 21.45 years. If Martin withdraws $201,500 of dividend income from his professional corporation each year so that he has $150,000 of after-tax funds available, the corporate investments will last 28.11 years.

From his sole proprietor savings, Martin will have realized $3.22 million in after-tax funds in retirement.  However, he would have realized $5.67 million of after-tax funds from his professional corporation. 

There was initially a difference of $1.53 million between the funds that Martin would have accumulated as a sole proprietor ($2.35 million) and the funds that Martin would have accumulated in his professional corporation ($3.88 million). This initial difference increased to $2.45 million ($5.67 million, less $3.22 million) in after-tax funds when considering the income earned on these investments throughout retirement. This difference is net of $5,000 in annual corporate expenses for filing and administrative costs.

Over 20 years, Martin’s total taxable earnings were estimated at a total of $8 million (20 x $400,000). The estimated additional cash available to Martin by using a professional corporation represents 30 percent of his total earnings ($2.45 million / $8 million x 100). 

Martin withdraws $100,000 in after-tax funds

Martin may find that his need for cash decreases in retirement. If Martin only required $100,000 of after-tax funds for his expenses in retirement, he would pay himself annual dividends of $124,000 and pay tax at an effective rate of 19.35 percent on this income.

Assuming the same three percent after-tax rate of return on investments, by taking annual dividends of $124,000 from his professional corporation, it would take 79.09 years to withdraw all the capital, and he would realize $9.8 million in after-tax funds.

On the other hand, his savings from being a sole proprietor withdrawn at $100,000 per year would last 41.23 years, and he would realize after-tax funds of $4.12 million. Although Martin will not live 79 years in retirement, it is an interesting comparison to see the difference between this and the previous scenario. 

The initial difference of $1.53 million in capital held personally as a sole proprietor ($2.35 million) and in a professional corporation ($3.88 million) has increased to a difference of $5.68 million throughout retirement ($9.8 million, less $4.12 million) in this scenario. This difference represents 71 percent of his estimated career earnings ($5.68 million/ $8 million).

From an integration perspective, employment income is deductible by the company and taxable to the individual. Dividends are not deductible in the company, but the effective tax rate on dividends for the individual is lower than for employment income to account for the tax already paid in the company on this income. 

Integration works well on active business income (ABI) eligible for the small business deduction (SBI) (generally, ABI < $500,000).  That is, when the business income earned in a professional corporation is flowed through the company to the individual in the same year (as employment income or dividends), the total corporate and personal taxes paid on the business income are roughly equivalent to the taxes that would be paid by an unincorporated professional who earned the same business income as a sole proprietor. 

However, wages and dividends have other differences, and each has advantages and disadvantages.  Sometimes, a balanced approach is preferred. We’ll briefly discuss some of the key advantages of each option below:

Advantages to paying wages

RRSP contributions

The ability to contribute to an RRSP is limited by earned income from the previous year. RRSP contribution room is calculated as 18 percent of earned income up to the annual RRSP deduction limit, which is indexed for inflation each year. 

Wages are considered earned income, but dividends are not. To have the maximum RRSP contribution for 2025 of $32,490, the incorporated professional would need employment income of at least $180,500 in 2024 ($180,500 x 18% = $32,490).

CPP benefits in retirement

If the professional would like to receive the maximum benefit from CPP in retirement, they need to receive a salary equal to the maximum pensionable earnings for the year ($81,200 in 2025). On this income, the employee and the employer are each required to contribute $4,222.10 for a total of $8,444. 

The maximum CPP benefit after retiring at age 65 is currently $1,433 per month or $17,196 per year. To receive the maximum CPP benefit requires having the maximum pensionable earnings for approximately 39 years.   

Individual Pension Plans (IPP)

Individual pension plans (IPP) can be an effective way for professionals to defer income and provide for retirement.

The employment income received by a professional during the years before retirement is used to calculate the pension income they are eligible to receive from the IPP in retirement and the contributions the company can make to fund the IPP each year. These calculations must be made by an actuary and updated regularly. As a result, there are annual costs to maintaining the IPP that need to be considered.

An IPP works similarly to an RRSP — except the corporation makes the annual contributions to the pension, which it deducts as an expense. The individual receives a pension adjustment that reduces the RRSP contributions they can make in the following year. The allowable contributions to an IPP are often more than may be contributed to an RRSP.

In addition, a history of paying wages may allow the company to make a lump-sum contribution upon the establishment of an IPP in recognition of past service by the owner-manager employee. However, early withdrawals from an IPP are governed by regulations and subject to additional restrictions than an RRSP. 

Budgeting for income taxes

When a professional receives employment income from their corporation, they are required to remit payroll withholdings for income tax and CPP. Withholdings for employment insurance are not required when you are related to the employer.

Receiving a portion of their income as salary and making the required payroll tax withholdings can help the professional budget for their income taxes each year. This can help alleviate the burden of the professional’s April tax balance due and the additional tax installments required in the following year.

Wages to family members 

Paying reasonable wages to family members for the services they provide to the business is one way to split income with family members.  

For example, spouses or family members will often provide bookkeeping and other assistance required by the business. The wages paid to family members will be taxed at their personal tax brackets. Provided the wages are reasonable for the work performed, they will also be deductible to the business. 

Bonuses are deductible when declared and taxable when paid

A bonus is deductible by the company in the year it is declared, provided that it is paid within 180 days of the company’s year-end. It is taxable to the recipient when it is paid. This mechanism can provide professionals with a deferral on paying the personal tax on a bonus deducted by the company in the prior year. 

For example, a company can declare a bonus payable to its owner that will be deductible to the company in December 2024 even though it is not paid to the owner until June 2025. Once it is paid, the company must submit the payroll tax withholdings to the CRA 

Advantages to paying dividends

Payroll remittances are not required

When a company pays a dividend to the shareholder, no payroll withholdings are required when the dividend is paid. There are still taxes required on dividend payments, but they are calculated on the individual’s tax return and will impact the tax installments required for the following year. 

Because there are no remittances required when dividends are paid, these can provide additional flexibility to remuneration planning for shareholders. In addition, those who view CPP remittances primarily as an additional cost of paying a salary may prefer paying dividends because no CPP remittances are required. 

Recovery of refundable taxes

Investment income such as rent, interest, capital gains, and dividends from portfolio investments are generally subject to refundable taxes.  The purpose of refundable taxes is to limit the tax deferral from earning investment income in a corporation.   

A company recovers its refundable taxes when it pays dividends to its shareholders. The individual shareholders then pay the personal tax on the dividends. To recover the refundable tax on investment income, the company must pay dividends to its shareholders. Paying wages won’t recover refundable taxes. 

Income splitting with spouses in retirement

The TOSI rules introduced in 2017 went a long way toward preventing income splitting with dividends paid to family members from a professional corporation. However, those restrictions were intentionally lifted in the year after the professional turns 64 years of age. As a result, it is possible to split dividend income with a spouse in retirement. 

Something to keep in mind is that to pay dividends to a spouse in retirement, they must be a shareholder of the professional corporation. In addition, their shares must have sufficient value such that paying them a dividend does not reduce the value of any outstanding preferred shares.

As a result, including your spouse as a shareholder on incorporation or adding them early in your career is generally encouraged. This will make it easier to pay them dividends in retirement.

Rules of thumb

There is no one-size-fits-all approach to the most tax-effective remuneration planning for professionals. It will depend on the specific needs of each professional and should be revisited annually as their circumstances may change.

However, below is a list of some general rules of thumb:

Retain income not needed in the corporation

One of the benefits of operating through a professional corporation comes from retaining income in the company that is not needed personally. This will defer the personal taxes on this income and may lead to permanent tax savings if you withdraw the funds from the company when you are in a lower tax bracket than if you were taxed on the income in the year it was earned. 

By investing the additional capital accumulated from the tax deferral in the company, you will benefit from the compounding growth of investment income earned over many years in retirement.

Add a spouse as a shareholder

Consider adding your spouse as a shareholder to your professional corporation if splitting dividend income with your spouse in retirement may be beneficial.

Limit wages and dividends to what you need

In general, limit your wages and dividends from the company to what you need for living expenses and RRSP contributions. Retain the excess income in your company and maximize the tax deferral that it provides.

Keep wages reasonable

Pay family members reasonable wages for their services.

Wages vs. dividends

During the productive years, it is generally preferable to pay wages. However, pay some dividends if you have refundable taxes to recover in your company — or if you need personal income over the threshold for earning RRSP contribution room (currently at $180,500). 

Avoid paying yourself dividends to recover refundable taxes if you don’t need the money and are in the highest tax bracket. Similarly, don’t pay yourself wages to increase your RRSP contribution room if you don’t need the money personally. 

Dividends are generally preferable during retirement for several reasons:

• There is less income in the company to use the deductions provided by wages.
• Investment income is usually higher in retirement, requiring dividends to recover refundable taxes.
• Dividends can be split with a spouse in the year after the professional turns 64.
• The incentive to pay wages to increase retirement benefits such as CPP benefits, RRSP contributions, and IPP contributions is no longer needed.

The effectiveness of integration largely depends on the types of income earned inside the corporation and a thorough analysis of the applicable corporate tax and personal tax rates for each shareholder.

It is generally understood that earning income within a professional corporation is costlier than earning the same income personally. However, the ability to defer personal tax and retain additional funds in the corporation can often lead to better long-term results. 

One of the advantages of incorporation is the ability to retain income in the company that you don’t require personally and defer the personal tax. To maximize the benefit of this tax deferral in retirement, one should withdraw the capital only as needed so that it is taxed in lower personal tax brackets than it would have been had you earned it as a sole proprietor, creating a permanent tax saving.

In addition, one should invest the additional funds retained in the company from the tax deferral and benefit from the compounding growth of the investments throughout retirement.

An incorporated professional can receive their annual compensation as employment income or as dividends.  Each option has advantages and disadvantages, so a balanced approach is often preferable. 

The best mix of wages and dividends for you will depend on a variety of factors, including:

• the amount of personal income needed each year,
• the mix of investment income and business income earned in your professional corporation,
• the ability to split dividends with another shareholder, and
• your ability to contribute to RRSPs and save for your personal taxes due in April.

It is important to review your personal compensation plan regularly with your accountant and tax professional. For more information about integration and the ideal compensation mix for you, contact your MNP advisor.