To Incorporate or Not to Incorporate, That is the Question

A quick internet search will reveal that there are three main ways in which you can own your business- sole proprietorship, partnership or corporation. This lesson will focus on the differences between sole proprietorships and corporations.

Sole Proprietorship Corporation
You are the business and the business is you Business is a separate legal entity
You are responsible for all the debts of the business There is protection of your personal assets
One tax return – business losses can be applied Two tax returns, corporate losses cannot be used to reduce personal income
All profit taxed at personal marginal tax rate Flexible tax planning
More difficult to raise investment Ease of investment – ability to sell shares
Can only sell assets of business Easier to transfer ownership
Perpetual existence

Thinking about it but worried about the cost? Don’t be scared by the costs of incorporation! The initial cost to set up a Federal corporation, between filing and legal fees, is just over $1,000. Cost of maintenance thereafter is $20 per year to file the annual return. To pay an accountant to file a corporate return each year will run you between $600 to $1,000.

If you’re making a decent profit in your business, the tax savings from incorporating more than make up for the added costs as will be shown in the example below:

If you make $100k per year and have $40k in business expenses, in a sole proprietorship the $60k in profit would be taxed at your personal marginal tax rate, regardless of whether you used all that money for your personal expenses or reserved some for the following year. After tax, using a marginal tax rate of 29.65%, you’d have $44,510 remaining.

In a corporation, you’d pay tax on dividends paid to you as a shareholder of say $30k, the total tax on which would be $450. The remaining $30k would be considered retained earnings and taxed, if you are a Canadian controlled small business, at 13.5% (in Ontario), leaving you with $55,501 total. That’s a difference of over $10,000 in tax savings!

Of course, the more profit you make, the more the tax savings. When you consider all the advantages of incorporation beyond the tax savings, it’s easy to see why I’m a big advocate of it.

So, when should you NOT incorporate?

The main reason why I would advise clients not to incorporate is if they still earn employment income AND your business is making a loss. If you are incorporated, you cannot reduce your taxable income by the losses your business has suffered as you can when you are reporting your business income on your personal tax return.

Also, if business is more of a hobby for you, you’re not making a profit after your expenses are taken care of and you don’t envision needing investment or wanting to sell it in the future, the advantages that incorporation brings may not be enough of an incentive to outweigh the increased administrative burden.

If any of this has made you go hmm, we should talk.

Click here to schedule a call with me

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