Should you incorporate to avoid CPP contributions?

Some taxpayers may not even notice this, but line 42100 on a T1 tax return is CPP Contributions Payable on Self-Employment Income and Other Earnings. Contributions are calculated on Schedule 8 or Form RC381, whichever applies.

Most self-employed individuals must pay CPP contributions, but there may be alternatives. Whether or not it is worth pursuing them is another story.

Opting out of CPP

If you are under age 65, you must contribute to the CPP if you earn a salary or self-employment income. Once you are 65, until age 70, you can elect to stop CPP contributions. 

If you are an employee, you must submit Form CPT30, Election to Stop Contributing to the Canada Pension Plan, or Revocation of a Prior Election to your employer(s) and to the Canada Revenue Agency (CRA). You must be receiving a CPP or Québec Pension Plan (QPP) retirement pension and be between ages 65 and 70. 

Self-employed taxpayers must complete Schedule 8, Canada Pension Plan Contributions and Overpayment (for all except QC) as part of their tax return by the filing deadline for it to apply for the previous tax year. Québec residents can opt out of QPP when filing their TP1 provincial income tax return.

What if you are under 65?

There is an option for younger taxpayers to opt out of CPP or QPP if they are self-employed. If they earn their self-employment income through a corporation they own and pay themselves dividends instead of salary, there are no CPP contributions payable. 

An owner-manager of a corporation can pay themselves dividends as a shareholder or salary as an employee. An unincorporated sole proprietor can incorporate to have this flexibility. 

Dividends are a distribution of after-tax corporate profits. The corporation pays corporate tax first on the profit, and then a dividend is taxed to the recipient shareholder at a lower personal tax rate to account for the corporate tax already paid. 

Salary is a deduction for a corporation. So, if a corporation pays out all its income as salary, it will have no income and therefore no tax. All tax would be paid personally.

The combined tax should be comparable between dividends and salary. There are subtle differences between provinces and depending on income level. And some deductions can only be claimed if you have employment income. 

At the highest marginal tax rate, Saskatchewan and Northwest Territories are the only places in Canada where dividends result in a lower integrated tax rate than salary. That said, the savings when paying salary are subtle—generally about 0.5% to 1.5%. NWT is the outlier with tax savings of over 3% for a high-income owner-manager to take dividends over salary.

Is CPP a tax?

CPP contributions are not really a tax, although they are administered through the payroll or income tax systems. These contributions provide a future retirement pension as well as potential disability or survivor pensions. 

It is a common misconception that the government is going to use the CPP for some other purpose or that it is not a pension that will be available for young people in the future. 

The Canada Pension Plan Investment Board (CPPIB) manages CPP funds and is “accountable to Parliament and to federal and provincial ministers, however, [they] operate independently [and are] guided by an independent Board of Directors.” The government cannot take money out of CPP. 

The 32nd Actuarial Report on the Canada Pension Plan was recently published and provides sustainable projections for the next 75 years. 

Many government public pensions around the world differ from Canada’s funded CPP pension, which has roughly $800 billion in assets. Some use primarily current year contributions to fund current pension payments, which has its risks with aging populations. The U.S. Social Security is projected by its trustees to have a funding shortfall by 2032, barring changes to contributions or pensions. CPP is an outlier.