Taxation in Active Versus Passive Business Income
What You Will Learn
Most Canadian business owners assume that incorporating automatically means paying less tax. This conversation between Richard Canfield and CPA Henry Wong reveals why that assumption can be dangerously wrong, and walks through exactly what happens to corporate profits when passive investment income enters the picture alongside active business income.
Key Moments in This Session
- Why and when to incorporate: the five main reasons business owners incorporate, including tax deferral, income splitting, deductible expenses, liability protection, and succession planning, and why around $100,000 in consistent annual income is a reasonable starting threshold before the costs and complexity of incorporation make sense.
- The three categories of corporate income and why they matter: how the same $100,000 flowing into a Canadian-controlled private corporation is taxed at 12.2% as small business income, 26.5% as active business income above the $500,000 threshold, or 50.2% as investment income in Ontario, and why the definition of the income determines everything.
- The personal service business and specified investment business traps: why contractors who serve only one client may be reclassified as employees by CRA and lose access to the small business deduction entirely, and why passive income from property, GICs, rent, royalties, or dividends inside a corporation is taxed at around 50%.
- The passive income threshold and the loss of the small business deduction: how earning more than $50,000 in passive income inside a corporation triggers a second test that can eliminate the small business deduction on all active income, escalating the effective tax rate on active earnings from 12% to 26.5% in addition to the 50% already owed on the investment income itself.
- The seven-cent problem: how a corporation earning $300,000 in active income alongside $100,000 in investment income ends up with only $7,000 more after tax than one earning active income alone, meaning the business owner kept just seven cents of every dollar of investment income earned, and why redirecting that capital into a tax-exempt vehicle inside the corporation eliminates this trap entirely.