Is Incorporation Right for You?
Written by Noah C. Jensen CPA, CA
*This article is for general information purposes only. Each individual and corporation’s needs are different and you should consult your Chartered Accountant and/or lawyer before acting on any of the information disseminated in this post.
One of the first questions that someone contemplating starting a business asks me is: “is it worth it to incorporate?” The answer, as with all tax and accounting questions, is “it depends”. I will explain the advantages of incorporating from the perspective of a Canadian Controlled Private Corporation and why you may consider not incorporating.
Division of income
If your cash needs require you to take money out of the business to pay your personal expenses, you will have income from either wages or dividends coming out of your company.
If your spouse’s income is less than yours, and you structure the share capital of the corporation appropriately, you can assign your spouse a reasonable wage for any services they perform on behalf of your company or issue your spouse dividends to split income.
An optimal couple’s tax rate is the same for both individuals. When this happens, your income and income tax is the same. Splitting the dividends between the spouse’s tax returns achieves this goal.
Deferral of tax
If you plan on reinvesting your earnings into your company to purchase property and equipment, inventory or other working capital, incorporation will benefit you. This is because the tax rate for a Canadian Controlled Private Corporation is only 15.5% assuming that you are eligible for the small business deduction and your taxable income is below $500,000/year.
Therefore, assuming you have positive earnings and cash flow from your business, you are able to reinvest in your business assets quicker vis-à-vis incorporation because you won’t be paying as much in taxes as you would as a sole proprietor assuming your net earnings are taxed at a rate higher than 15.5% (i.e. your business income on your return exceeds approximately $10,000).
Limit of legal liability
The corporation is a separate person from you. Any trouble the corporation may get into, such as an employee launching a lawsuit or a customer/supplier suing you, will be limited to the assets of your corporation. The plaintiff will generally not have access to your personal assets.
The sale of a business that is a corporation is generally easier to sell than a sole proprietorship. It is rare for proprietorships to be sold, as this exit strategy is more popularly done by a corporation.
The advantage to selling shares of a Qualified Small Business Corporation (“QSBC”) is that you are eligible for the Lifetime Capital Gains Exemption (“LCGE”) of $750,000 ($800,000 in 2014). Moreover, this applies to each shareholder, so if your spouse owns shares their share of the capital gain will be eligible for the LCGE as well doubling the exempt amount. Meeting the QSBC tests is worth its own article (I will endeavour to post one soon).
The downside to incorporation is the cost. Cost of incorporation from a legal perspective will range from $1,000-$2,000 (one-time fee) on start-up depending on where you are located in Canada, the complexity of the structure and how unprepared you are going into the lawyer’s office. Ask your lawyer if they would consider a payment plan if you are using bootstrap financing.
Accounting fees are based on the amount of time that it takes to complete the various government filings you will be required to complete. Generally speaking, there are more filings and more work that is required than a proprietorship. Consult your accountant who will be able to ascertain the amount of time required to prepare your corporate financial statements and tax return. If you currently use a bookkeeper for a proprietorship, I recommend getting a professionally designated accountant to prepare your financial statements and corporate tax return as they generally have E&O insurance and will be more familiar with the complexities.
Oftentimes, a good accountant can save you as much or more than your fee so don’t cheap out!
All things considered, incorporation would not be valuable to you if you plan on drawing all or more of your net earnings for the year, do not need to split income because your spouse already makes considerably more than you, have no plans to sell or otherwise succeed your business to another party (children, purchaser). I find these attributes most common in “side businesses”. Speak with your accountant and/or lawyer to ensure you are making the right decision.
Noah C. Jensen CPA, CA
Szczepski, Racolta, Jensen & Co. LLP
485 Pinebush Road, Suite 304, Cambridge, Ontario
519-622-1485 ext. 111