You've come up with that great business idea, and suddenly it's taking off. You've heard about moving your business to a corporation, but aren't sure whether it's right for you.
This blog will discuss some of the advantages and disadvantages of incorporating your business:
This blog will discuss some of the advantages and disadvantages of incorporating your business:
Cost
A major concern for any business owner - how much is it going to cost me? Incorporating costs approximately $400 in government fees alone - add to that lawyer and accountant fees that may also be required. There is also the added cost of filing and preparing corporate income tax returns annually.
Despite the higher cost, a corporation may allow you to defer some of the tax you have to pay on your income, since the small business tax rate is lower than the tax rate you would be paying personally. When you take the money out of the company you will end up paying approximately the same rate of tax as if you earned the income personally, but as long as the profits remain in the company they can be reinvested and defer tax in perpetuity.
As an example, say your corporation made $100,000 in profits. After corporate tax, you are left with $84,500. If paid out as a dividend, you would be left with approx. $50-60,000 personally (depending on your personal income tax level). By deferring tax at the personal level, you are able to invest a higher amount of capital and achieve a higher total dollar return.
Despite the higher cost, a corporation may allow you to defer some of the tax you have to pay on your income, since the small business tax rate is lower than the tax rate you would be paying personally. When you take the money out of the company you will end up paying approximately the same rate of tax as if you earned the income personally, but as long as the profits remain in the company they can be reinvested and defer tax in perpetuity.
As an example, say your corporation made $100,000 in profits. After corporate tax, you are left with $84,500. If paid out as a dividend, you would be left with approx. $50-60,000 personally (depending on your personal income tax level). By deferring tax at the personal level, you are able to invest a higher amount of capital and achieve a higher total dollar return.
Risk
All businesses have some element of risk to them. If you operate a sole proprietorship, and run into financial difficulty, you are personally responsible for all debts and other obligations of your business. If incorporated, the general rule is that as a director of the company, you will not be responsible for debts of the business, other than specific debts covered under director's liability (ex/ GST/HST, employee deductions). This will apply as long as you haven't acted with gross negligence or committed fraud.
Disclaimer - this is a very general definition and I am not a lawyer - if you are concerned about what you are liable for as a director you should seek legal counsel.
Disclaimer - this is a very general definition and I am not a lawyer - if you are concerned about what you are liable for as a director you should seek legal counsel.
Record Keeping
With any business, keeping adequate records is a must. Some sole proprietors find it difficult to keep track of their income and expenses, since everything is registered in the individual's name. While there are ways around this (ex/ opening a separate bank account for the proprietorship), having a separate legal entity makes it easier to keep track of all business related transactions. If something is business related, flow it through the company. If not, use personal funds to transact.
Every year, regardless of the form of business, an income statement showing the business' revenue and expenses must be prepared for tax purposes. A corporation also requires another type of financial statement called a balance sheet, to be prepared as at the end of each Fiscal year. This statement shows the company's current financial position (i.e. the assets it owns (cash, accounts receivable, equipment, etc.) and the liabilities it owes (accounts payable, bank loans, etc.)) as at the end of the year. Preparation of this statement requires more record keeping than just an income statement.
Every year, regardless of the form of business, an income statement showing the business' revenue and expenses must be prepared for tax purposes. A corporation also requires another type of financial statement called a balance sheet, to be prepared as at the end of each Fiscal year. This statement shows the company's current financial position (i.e. the assets it owns (cash, accounts receivable, equipment, etc.) and the liabilities it owes (accounts payable, bank loans, etc.)) as at the end of the year. Preparation of this statement requires more record keeping than just an income statement.
Tax Planning Opportunities
A corporation provides an individual a much broader variety of tax planning opportunities in order to minimize the amount of tax that is paid. A common strategy includes adding family members as shareholders of the company for income splitting purposes (i.e. both you and your spouse can receive dividends from the company even if only you run the company).
Overall
Whether or not to incorporate will depend on each individual's situation. If you are running a business and spending almost all of the profits each year, then there is less incentive to incorporate for tax deferral reasons, however the reduction of risk could be a major factor in your decision, depending on your line of business.
As always, please contact me if you have any questions or would like assistance deciding whether incorporation is right for you.
Cheers
Jacob
As always, please contact me if you have any questions or would like assistance deciding whether incorporation is right for you.
Cheers
Jacob