Personal Tax Rates Vs Small Business Rates | Edmonton Accountant
What is the highest personal tax rate in Alberta Right now? 48% is the highest marginal rate.
Yeah, I can see why cause it’s mad.
Hi. Thanks for joining us for another episode of ask a spiral CPA. Today we’re talking about personal tax rates versus small business tax rates. Uh, you know, Trevor, I think you’ve probably seen all that. What it looks like when you, you’ve owned businesses and worked in businesses and what the, what, what your check looks like when you, when you, when the government just reaches in and grabs and it takes it out. Nothing is more painful. Then when I was working construction and you get that coveted over time and a, you just think, Oh man, I’m going to be making so much money on this check. It’s going to be ridiculous. And then you see, oh no, I just gave Paul that back to the government because I was employed by somebody else and not taking advantage of the tax benefits we’re going to talk about today.
Yeah. So the quote that we have here on your personal tax rates or as a small business tax rates as Michael Gerber quote, you know, author of our favorite e myth in the fe, the fatal assumption is if you understand the technical work of a business that you somehow understand the business that does that technical work. And those are two separate things. And the statistic is the Fraser Institute tells us that the average Canadian pays 43% of their income in taxes. That’s tax CVP, e, I g, s, t, fuel tax, property tax, etc. And by comparison, on average, only 37% of the remaining income goes towards the basic necessities, shelter, food and clothing. So we’re spending more on tax then shelter, food and clothing. Um, and the story that we have here are business owners. They’re not yet incorporated and their pay way too much tax. And even sometimes the ones who are incorporated, they’re not utilizing the corporation.
Do you know its highest capacity in minimizing their tax obligations? So what are the questions you think these business owners need to be asking? Well, I think number one is what is the highest personal tax rate in Alberta Right now? 48% is the highest marginal rate. You know, it wasn’t too long ago that, oh Scott, only 39% and well, you know, in the last uh, few years it’s jumped from 39% of the Alberta advantage to 48% and welcome to the new order. Wow. So what is active small business income? So active small business, they come, this is income, that’s mean from an active business. So it’s different than you know, income that’s not passive income. So passive income would be rental income, income from investments in the stock portfolio, dividends and the on bonds. These are passive Vaco, but active business income is income from an active business.
Okay. So know what tax rate is. Act as small business income with a corporate tax, blah, blah. So if, if you have active business income and you generate it in a canyon controlled private corporation, it’s going to be taxed at 11% currently in Alberta, which is far better than the 48% margin or anything that you could be subjected to about other roles. Holy Moly. So now do you have to be incorporated to get that tax rate? You do. So there is no way to get that 11% tax, that small business tax rate. If you’re not incorporated, you’re just going to be subjected to the regular personal marginal rates up to 48% if you are not incorporated. Wow. So how much income can you earn on an annual basis at this rate? $500,000 a year at 11%. Uh, so we, it is not unusual to have a very highly paid professional, you know, with effective tax planning, paying and all in rate of maybe 20%.
Someone who’s making several hundred thousands a year. Uh, whereas the average Canadian has paying 43% and the average Canadian is not making several hundred thousand dollars per year. Edmonton Accountant, so you know, you can earn as much as $500,000 beer at 11% if you’re set up the right way. Wow. Now, so, Edmonton Accountant, how have this tax rate helps someone accumulate wealth? So you, you know, someone who’s otherwise paying 48% in tax that you get an extra $10,000 and that extra $10,000 is, you know, over and above what they, they need to live on or operate their business. Um, that $10,000, they’re going to pay, you know, 400, they’re going to pay $4,800 in tax. They have $5,200 to invest, um, in, whereas if they’re incorporated, that same person on an extra $10,000 can pay 1100 bucks, net $8,900 to invest. You do that year after year, you’re investing 8,900 instead of 5,200.
And it’s continually growing at that same rate of return. Edmonton Accountant, you know, the person who was in corporate is just going to accumulate wealth at a significantly accelerated rate. Wow. So now, how can a corporation even help you eliminate personal debt quicker? So it’s, it’s so extreme, the tax rate on, you know, what it’s going to be personally as, uh, as opposed to corporately is as I once assemble the model, I was doing a speaking engagement for a bunch of new doctors and they’d heard the old adage of, you know, don’t incorporate until you pay down on your personal debt. And I assembled the model up for them. So two doctors, you know, one who had, you know, a debt at 3%, um, and the, the debt was, I, I believe at the time he was $250,000 and they had so much extra income per year.
Edmonton Accountant, and the one doctor, he paid down that, that debt every single year, uh, with that extra income. But of course he had to earn that income then pay that, you know, 48% rate. And I think in the model that I only use 40% just to make it a little more conservative and it took the, the, the doctor 24 years to eliminate that debt. At that rate. And then I took that same professional and said, okay, I’m just going to make the minimum payments on that debt. And I’m going to say within the corporation, that same doctor would have enough money in the corporation by year 16 to take it all out and pay down the debt. So if they took it all up and paid the 48% year after year, and they would never get that money working for them, uh, they would simply be paying down the debt at 3%.
Uh, it would take 24 years to eliminate the debt. And that in the same model, they were able to save at 7%, you know, a historical rate of return on a savings. Uh, in 16 years they could if they wanted to take all the money out of the corporation and eliminate the debt. Uh, so when you start looking at the tax rates that way, that even mathematically, even if your goal was to be completely debt free, you’re probably not best off taking that out each and every year and subjecting yourself to that high marginal read. Wow. So now do the personal tax rates make it difficult to buy business assets? Yeah, if you’re not incorporated, a lot of people think that, you know, I can take the assets, the profits from the business and simply by business assets and I’m not going to be subjected to those personal rates.
Well those are assets. They’re non expenses. So you want to turn around and you want to buy a truck or a computer or an x ray machine for your business and you’re not incorporated for it. You know, that same $10,000 it’s not available to buy the asset. You got to pay your, your 48% or somewhere up to 48% and then that $5,200 is now available to pay the by that personal assets or that same person operating the same type of business who’s incorporated, you know, they pay their $1,100 on that extra canon. They have $8,900 to buy bigger and better and faster equipment and they’re not going to pay as much to finance it cause they’re not boring to do it. Wow. Do unincorporated businesses have to pay CPP in addition to tax? Yeah. So you usually the business owners, they’re pretty good. They, they, they get the power of Google and going and they start looking up the tax rates.
You know, I pay this much in the first 50,000 and this much on the next 40,000 this much after that. And they have a good idea of what the tax rates are coming in or some business owners do anyways. Edmonton Accountant, but usually what they forget about is the CPP that they have to pay on top of the tax if they’re not yet corporated. Uh, and it’s usually about 10, it’s roughly 10% on the first $50,000. So there’s an additional $5,000 and CPP that’s paid in addition to the tax people say $5,000. That seems like a lot for CPP. Edmonton Accountant, but really once you’re, when you’re self employed, you have to pay not just the employee portion that you’re used to paying when you, you had a regular t for job, but you also have to pay the employer portion. And that’s a lot of people don’t really realize about that is for every dollar you are paying in Cvp, your employer was chipping and another dollar on top of it.
And when you’re self employed, you’re paying both of those dollars and it were soaked to little five grand every single year. Wow. So will a corporation help you spread out and reduced tax from hiring come years? Yeah, so one of the, the benefits of a of a corporation is you can choose when that money, you know, gets broadened, it brought in as personal income or if it does even. Edmonton Accountant, but when your proprietor, if you have a big year, you have to pay tax on that big year in that big year. Um, so let’s break this down into an example where let’s say you’re a, uh, a lawyer and you know, you’re, you’re a lawyer and you have a couple of big cases and next year you’re going to take some time off. Well now you have to pay tax at this crazy 48% rate when you could have spread that Tac. So over two years and pay less tax because you know, the tax rates go up, the more and more money you make.
So you can, you know, effectively pay tax on money on this over a couple of years. And we have, you know, some women who are clients, you know, and they go on maternity leave as a, as an unincorporated person. So they pay crazy tax and one year and then no tax and the next year, and of course they’re not getting EEI because they’re, they’re self employed. Edmonton Accountant, when they could have used those that other year to spread out their tax, they could have paid tax, evenly paid less tax and you know, took full advantage of the marginal rates. Edmonton Accountant, and you know, spread that tax over time. So what are some of the secondary benefits of incorporation so that, you know, the secondary benefits of incorporation or num? Number one, it’s limited liability. So it’s, you know, dramatically decreasing your risk of, of personal liability and it was helping you protect a trade name.
It’s giving you an avenue to raise funds. Uh, you know, you get any business loans. It gives you that element of legitimacy to a in the business. So there’s a number of, you know, the secondary items and also, you know, people, some people just won’t hire you if you’re not incorporated. It’s so, uh, there’s a number of these secondary, you know, benefits to incorporation that people should consider as well as just the dollar in the sense. All right, so if someone is only concerned with tax, when should they look at incorporating? Yeah. So it, it’s, if they don’t care about any of these other secondary benefits, they say, I’m never going to get sued or I have no assets to guard against anyways. Okay. I guess. Edmonton Accountant, but if they’re only looking at it from a spreadsheet perspective, usually like $50,000 is like a breakeven point for most people in most circumstances.
That can change from circumstance to circumstance. But a lot of people, if you’re not incorporated and you’re making $50,000 a year in this business, you’re probably paying more money to not be incorporated. So instead spending the extra money to your accountant or lawyer to get the corporation set up, you’re sending more than that, uh, to the federal government, the provincial government, every single year to, to not be incorporated. Hm. So I think that’s what we have here today, uh, on personal tax rates versus small business tax rates. As always, you’ll please hit the like and subscribe buttons so we can continue to deliver your tips on how to beat the odds at business. And if you have any college, we’d love to hear them in the comment section below so we can, uh, you know, respond back to you and use your, your feedback for future videos. Thanks very much.