So your business is starting to earn more money, and with that – you’re paying more taxes. Is it time to consider incorporation? The answer isn’t that simple.
The more income your business generates, the more advantageous incorporating may be to reduce your taxes. However, minimizing your taxes shouldn’t be the only motivation for your business or practice. You should also consider:
- Are your personal assets at risk from your businesses’ liability?
- Are you planning to sell your business down the road?
- Could you benefit from succession planning?
- And most importantly, have you spoken with a professional about the benefits (or risks) of incorporation?
What is a corporation?
A corporation is a legal entity that is separate from its owners. The corporation issues shares to its owners/shareholders. Being a separate legal entity, the corporation pays corporate income tax and has additional filing requirements and obligations in addition to those of a sole proprietor.
Pros of Incorporation:
- Limited Liability – Because a corporation is considered a separate entity, operating your business through a corporation provides an additional security layer against personal liability. Although your liability as the owner may be limited, directors of the corporation may be held liable for any unpaid amounts of income taxes, sales taxes, etc. To further understand the protection level from personal liability, talk to your lawyer regarding the limited liability available before incorporation.
- Tax savings and deferral – Incorporating your business may allow for you to defer and save taxes compared to continuing to operate your business as a sole proprietorship as corporate tax rates are often much lower than personal tax rates. For 2020, a Canadian-controlled private corporation operating in Ontario will be subject to a corporate tax rate of 12.2% on the first $500,000 of active business income. In comparison, a sole proprietorship with income over $220,000 would pay personal income tax at 53.53%.
- Capital Gains Deduction – A potential advantage of incorporation is the ability to claim the lifetime capital gains deduction on the sale of shares of a qualifying small business corporation. Eligibility for this deduction is subject to meeting various criteria, and it is recommended you have a conversation with your tax accountant as to whether your business may qualify.
Cons of Incorporation:
- Compliance Costs – Whether you’re setting up your corporation provincially or federally, there are initial setup and ongoing compliance costs that you would not incur as a sole proprietor. Having a lawyer and accountant on your side to assist with the initial set up and ongoing filings of the corporation will ensure your corporation is set up properly and alleviate any issues with the annual legal and/or tax filings.
- More administrative work – When operating your business through a corporation, there is a lot more administrative work involved that will require your attention and an additional time commitment. Information relating to your corporation should be kept separate from your personal affairs. You will be required to gather and provide all the corporation’s information required to prepare the annual financial statements and corporate tax return. Further, additional legal filings may be filed for the corporation to be filed to remain compliant and in good standing with the authorities.
- Limitation on use of losses – If your business sustains operating losses, those losses may be trapped inside the corporation and not utilized to reduce prior year/future taxes. As a sole proprietor, any operating losses incurred may be used against all sources of personal income.
Are you still debating whether to incorporate your business or practice? Your first step should be getting support from a trusted professional. If you’re considering whether to incorporate, you need professional expertise personalized to you, your goals, and your business.
For some of RLBs clients, this means having a consultation to understand the current state of the business, short and long-term goals, and where they see themselves in the future. If you have any questions or concerns about whether or not to incorporate your business, reach out to us for a free consultation.
Written by Nicole Boucek and Alexander Di Lello
