The US-Canada border is one of the friendliest in the world. As a result, many people move back and forth across the border. I am one of those people. I grew up in Canada, went to university and worked in the US, moved back to Canada for a few years, and now live back in the US.
It’s important for people considering moving across the border to understand the difference between the two countries' tax systems and other factors impacting cost of living. Although the principles in each country are similar, the implementation is quite different.
I’ve been writing a series of posts on the topic, including various topics, tax agencies, impact of moving, filing status, and income tax rates, deductions and credits, payroll tax, health care and other insurance, and capital gains.
In this post I’ll compare small business tax.
Small business owners will find business tax to be one of the most significant differences between the two countries. As you will see, the difference is more in the structure than the total tax burden.
Sole proprietorships are the most simple business structure, and they are treated roughly the same in both Canada and the US. Beyond that, business tax structure is quite different between the countries.
Canada: Corporations are king
In Canada, most small businesses operate a C Corporations. This is surprising to Americans who are double taxed at at very high rates when using C Corps.
There are two reasons C Corps work in Canada:
- The federal corporate tax rate is much lower (15% in Canada vs 34-35% in the US - yes, only 15% - you American read that correctly)
- The small business deduction reduces the federal corporate tax rate to 11% on the first $500,000 in taxable income
Provinces also have a regular rate and small business deduction rate. In Alberta, for example, the rate is 3% on the first $500,000 (14% combined federal and provincial) and 12% above that (27% combined federal and provincial). Provincial rates in Canada are higher than state rates in the US, but the combined rates are still much lower in Canada.
Important caveat: the small business deduction is subject to some restrictions, including the requirement that the corporation be a Canadian-controlled private corporation (CCPC). To be a CCPC, Canadian residents must own a controlling interest in the corporation. If you and/or your spouse control the corporation, and it continues to do business in Canada after you move to the US, it will lose CCPC status.
Aside from tax rates, corporations allow income splitting between spouses. Even if one spouse does all the work for the corporation, both spouses can own the corporation and take dividends in proportion to their ownership. This isn’t an issue in the US where spouses file together, but in Canada spouses file separately.
Income splitting of regular income under certain conditions was recently added to Canadian tax law, but the newly elected Liberal government would like to repeal it. Until this change was made, corporations were one of the only ways for spouses to split income. They may soon return to that status.
Of course, money taken out of a corporation by the owner is included in the owner’s personal income. Personal income tax can be deferred indefinitely by leaving money earned by the corporation in the corporation. That money can then be invested in assets unrelated to the main corporate activity.
Many owners use corporations to build wealth with minimal taxes. For example, an attorney who earns fee income through a corporation can take just enough out of the corporation to live on and invest the rest in assets like rental properties, mutual funds, etc. This is the single biggest advantage of using the C Corp structure.
Finally, money taken out of a Canadian corporation is not double taxed. Money taken as a salary or bonus is deducted from the corporation’s taxable income, preventing double tax.
Unlike the US, even income taken as dividends is not double taxed. The ingenious Canadian tax code writers devised a way, in theory, to make owners indifferent to taking income from a corporation as salary or dividends. It’s too complicated to get into here, but income taken as a dividend can be partially credited against personal income tax. As a result, there really isn’t much difference either way in the amount of total tax paid.
Corporate tax in Canada can be complicated. Like the small business deduction, some tax rates and other benefits are subject to restriction. However, if your Canada corporation is complicated enough to worry about these restrictions, you probably wouldn’t be reading this post for tax information anyway.
US: LLC’s rule
US small business tax is much simpler. The C Corp structure is only used by businesses that are either large or have a large number of shareholders.
Many small businesses in the US operate as LLC’s. LLC are much easier to set up and maintain than corporations. LLC’s provide personal liability protection, and the tax structure is like a sole proprietorship or partnership. The LLC itself is not taxed. The LLC’s net income flows through to the owners’ personal tax return and is taxed as ordinary income.
I wrote a post here about the different types of LLC’s.
Are you American business owners ready to move to Canada yet? Are you wondering why I moved to the US?
Well, before you get too depressed, realize that corporations in Canada are not a huge advantage. Rather, Canadian tax law has simply removed the disadvantage of using a C Corp for small business. Since small business don’t use C Corps in the US anyway, nothing is lost.
If anything, Canadians should be disappointed LLC’s are not available in Canada.
Even though the structure is much different, most small business owners wouldn’t notice much of a difference in their overall tax burden.
I mentioned in previous posts that my tax bill went up slightly when I moved to the US, but it was only because I was able to use a corporation to split my income with my wife. Without this benefit, my Canada tax bill would have been slightly higher.
The biggest advantage in Canada for small business is the ability to keep money in the corporation and avoid the personal tax component. However, most people need most of their business income to live on, negating this benefit.
The bottom line: most small business owners won’t see much of a difference in their total tax bill between Canada and the US, but it is important to understand the difference in structure.
Disclaimer: I am a CPA in both Canada (Chartered Professional Accountant) and the US (Certified Public Accountant), but I am not a tax expert and this post is not meant to be professional advice. My goal is not to write a definitive guide. Rather, my goal is to give you a starting point for your own further research and/or discussions with your tax advisor.