Considering Incorporation? What You Need to Know
Almost every business owner comes to a stage in their business when they start considering incorporation and whether it makes sense for their business.
Whether you’re just starting out as a sole proprietor or a partnership, you should take note of the advantages and disadvantages of incorporation.
Most small businesses start out as sole proprietorships or partnerships and then as the business grows, they incorporate.
The legal structure of your business can change as it grows, so it’s worth getting informed before you take the leap to incorporation at initial start-up.
Advantages of incorporation
The main advantage of incorporation is separating your personal assets from your business assets.
Limited liability means that each shareholder (owner/partner) of the business is limited in liability to what they have invested in the business.
From a legal perspective, the business is now considered a separate legal entity and is subject to corporate tax rates.
Also, should there ever be any lawsuit against the business, the owners’ personal assets are protected.
Whereas, under the structure of a sole-proprietorship or partnership, the personal assets of the owners can be seized to pay the debts of the business.
When you incorporate a business, it has the same rights as an individual and can own assets and incur liabilities.
Income Tax Advantage
Another huge benefit of incorporation is that business tax rates are much lower than personal tax rates.
The combined federal and provincial personal tax rates for 2017 range anywhere from 25.8% to 50.4%!
When you incorporate, your business is classified a Canadian-Controlled-Private-Corporation (CCPC) and is entitled to the small business tax deduction on the first $500k of income.
The tax rates on a CCPC are 10.5% to 18.5% on the first $500k and then 26% – 31% on any income above $500K.
However, keep in mind that this tax advantage is merely a tax deferral for the owners since the business is going to want to pay its shareholders at some point.
Therefore, as the profits are paid out to the shareholders, these individuals are then taxed at personal tax rates on their individual tax returns.
The rules around other tax advantages such as capital gains exemptions are complex, and professional advice should be obtained for anyone who is hoping to take advantage of this deduction.
Incorporation creates the ability to pay dividends to shareholders, and those shareholders do not have to be actively involved in the business operations to be entitled to the dividends.
For example, a spouse or child could be a shareholder in the business which allows the corporation to distribute income to family members at lower tax brackets.
Disadvantages of Incorporation
With incorporation, come additional expenses to the business.
The cost to incorporate can range from $500 – $3,000+ – depending on the size and complexity of your business before you incorporate.
Although you can continue as a sole proprietor, be aware that your income will be taxed at personal tax rates as high at 50.4%.
If you earn say, $50k or so through your business, you may be fine from a tax perspective to stay a sole proprietor.
Once, however, you start earning well above that level, you may be missing out on ways to more effectively manage your taxes.
And while you can incorporate your business on your own, it can be complicated and it’s advisable to get the help of a lawyer and accountant.
An incorporated business must file a separate tax return.
Corporations must maintain annual corporate by-laws and minutes from corporate meetings.
A few other things to maintain include financial statements, separate bank accounts and detailed bookkeeping.
Losses in an incorporated company can’t be personally claimed.
Rather the losses realized by the business can only be used against future corporate income.
This means that you cannot personally use the business losses to reduce any other income you personally earn.
So is it Worth Incorporating?
Generally, the higher the net income of your small business, the more advantageous it is to incorporate.
Each type of business structure has its advantages and disadvantages.
It’s best to seek professional advice to assist in your decision-making, and in the setting up of your business structure.
To get advice on which structure would best suit your business, click below to contact me today!