LIMITED LIABILITY (‘you can’t sue me’! – John Cena)
The main advantage to incorporating is the limited liability of the incorporated company. Unlike the proprietorship/partnership, when a business becomes incorporated, an individual shareholder’s liability is limited to the amount he or she has invested in the company.
If you’re a proprietorship/partnership, your personal assets, such as your house, car or toys can be seized to pay the debts of your business or the settlement of a lawsuit. As a shareholder, you can’t be held responsible for the debts of the corporation unless you’ve given the bank a personal guarantee.
On the other hand, a corporation has the same rights as an individual; a corporation can own property, carry on business, incur liabilities and sue or be sued.
CORPORATIONS LIVE LONGER THAN KEITH RICHARDS
Unlike a proprietorship/partnership, a corporation will live forever. Corporations are much easier to sell than proprietorship/partnerships and can be sold and/or given to family members. The corporation also survives if a shareholder wants to leave the Company.
It’s not exactly a money tree, but if you are trying to grow your business it is much easier to do so inside of a corporation that only pays tax at 12% (assuming the SBD is used). With a proprietorship/partnership, you are forced to pay income tax on whatever income is for that year. At $75,000 of personal income your personal tax rate is 28% (almost 3 times more tax).
The other advantage is outside investors. If there is a desire to grow the business or increase the number of shareholders, this can be accomplished much more easily with a corporation. The sale of shares can easily raise capital inside the corporation.
PLANNING INCOME AND TAXES
If you incorporate your small business, you can determine when and how you receive income from the business, a real tax advantage. You can also receive income from an incorporated business in the form of dividends as opposed to salary, which will lower your tax bill.
If your corporation happens to suffer a loss in a year, the losses can be applied to other years of income and give you a corporate tax refund.
Becoming incorporated gives you tax deferral potential if you are a higher income earner. Business tax rates are much lower than personal tax rates, so if your individual marginal tax rate is high and you don’t need the funds for personal use, you can elect to leave money in the business and take it out at a later date when your personal tax rate is lower.
For example, say your business had $150,000 in earnings after expenses for the year:
- If you and your spouse took out the entire $150,000 as salary (and had no deductions), you would pay $42,000 in personal taxes, with a marginal tax rate of 28%.
- If you and your spouse took out $75,000 as salary, you would pay $15,000 in personal taxes, with a marginal tax rate of 20%. On the $75,000 left in the company, the corporate tax would be 10% – $7,500. Your total tax in this scenario would be $15,000 in personal tax + $7,500 in corporate tax = $22,500, a savings of $19,500 in taxes vs taking out the entire $150,000 as salary.
ANOTHER TAX RETURN!?!?
When you incorporate your small business, you will have to file two tax returns each year, one for personal and one for the corporation. This will mean increased accounting fees. The fees to file your personal taxes will no longer be a business deduction as the business’ taxes are completed in the corporate income tax return.
INCREASED PAPERWORK AND LEGAL
There is more paperwork involved in maintaining a corporation than a proprietorship/partnership. Corporations, for example, must maintain a minute book containing the corporate bylaws and minutes from corporate meetings. Your lawyer will keep other records up to date such as the Register of Directors and the Share Register as well as filing the annual report. And of course…lawyers don’t work for free!
BRINGING A CORPORATION TO LIFE - MORE EXPENSIVE THAN FRANKENSTEIN
The legal fees to incorporate a business are around $1,300 (Fleming and Associates). A corporation is a complex legal structure, so it’s logical that creating one would be more complicated and costly. This is a one-time fee, but there is an annual report to be filed each year and this costs roughly $200-$300.
Accounting fees to file a corporate income tax return and generate financial statements are around $1,500/year. The costs to close a corporation are also high as the Certificate of Dissolution and the final tax returns could easily run up legal and accounting bills upwards of $2,000.
So should you incorporate your small business? – maybe.
You should discuss your personal situation with your lawyer before you decide. The purpose of this report is to give you food for thought and not a recommendation. Your lawyer will have additional information that I do not have access to and will be the best suited to advise you on such matters. They will be able to give you a much more exact picture of how incorporation could benefit your business, and help you see whether or not the trouble and expense of incorporation will be worth it to you.