Should you incorporate your small business?

This is a difficult decision that many small business owners face at the start of their business or when they experience early growth.

“When is the right time to incorporate and what does this mean? And if not, how should I structure my business?”

Well, first you need to know the different structures a business can take shape and the right structure will depend on many different factors that are specific to your situation.

Small businesses can be structured as a proprietorship, partnership, or corporation.

Proprietorship

One person operating a business without forming a corporation.  Net income is considered self-employed income and taxed at personal tax rates.  The business statement is filed and incorporated within the personal tax return.

Advantages

  • Simple to setup and costs are low
  • Losses from business can be written off against other personal income
  • Less regulated than corporations therefore administration is lower, but CRA registrations follow the same requirement as corporations for taxes remittances
  • Profits are under control of owner and fully taxed under the personal tax rates

Disadvantages

  • The biggest disadvantage is unlimited personal liability, therefore personal assets are at a high risk
  • If business is profitable, it will be paying higher tax rates at personal level versus corporate, personal 20% to 46% in 2014 versus corporate tax at 15.5% up to $500,000 net income
  • Lack of performance – if owners dies, net business assets passes to heirs but valuable leases and contracts may not

Partnership

This form of business is similar to the structure of a Proprietorship, except two or more entities are partners in the business.  Partners can be individual or corporations, for individuals the net income is split between partners according to their agreement and taxed at personal tax rates by each individual.

Advantages

  • Setup costs are low
  • Losses from business can be written off against other personal income for each individual
  • Less regulated than corporations, but a partnership agreement should be in place to prevent disputes between parties at a later stage of the business
  • A broader pull of resources, knowledge and skills are drawn from partners

Disadvantages

  • The biggest disadvantage is unlimited personal liability for each individual partner. Partners are jointly liable for the business, therefore personal assets are at a high risk.  Exception of this is Limited Partnership, which is who contribute capital but do not participate on the operations of the business, therefore their liability risk is limited to the capital invested
  • Decisions must be done jointly among partners
  • If business is profitable, it will be paying higher tax rates at personal level versus corporate, personal 20% to 46% in 2014 versus corporate tax at 15.5% up to $500,000 net income
  • The death or retirement of a partner will not end the partner’s liability risk

Corporation

A corporation is a separate legal entity, formed under federal or provincial government. Corporate shares are issued to owners, the shareholders. Investment can be done through shares or loans to the corporation. Shareholder loans can be paid back when cash available in the corporation without triggering personal tax.

Advantages:

  • One of the biggest advantages is limited liability which is usually limited to the amount invested in the shares of the corporation. However, in order for many small business to acquire loans from the banks, they require shareholders to give a personal guarantee to the extent of the borrowings value
  • Personal assets of shareholders are protected against lawsuits of the corporation, however directors of the corporation are liable for some debt such as HST and payroll taxes
  • Owners have different ways of receiving income from the company, regular wages, bonus or dividends, which can be planned for tax purposes
  • Another major advantage, is corporate tax at 15.5% on active net income up to $500,000
  • On sale of shares of a qualifying small business corporation, shareholders will benefit of a $850,000 capital gains exemption, therefore saving significantly taxes on the transaction profit

Disadvantages:

  • Incorporating is the business structure with the highest setup and administrative costs
  • Incorporation is complex and it is very important the right structure is in place if more than one company is to be setup, and is very important to take extreme care in setting up classes of shares and deciding who will be the shareholders (spouses, children) and how much control they will have (control is determined by % of voting shares owned). Professional advice can avoid serious problems, you should never do this on your own and self-serve online to prevent costly problems later on at a different stage of your business
  • Business losses cannot be written off against other individual income of shareholders, but can be carried forward to decrease taxes in future years or carry back a few years. Losses are never lost within the corporation
  • More administrative work is required, including annual reports filed with CRA which are separate form personal taxes

Each type of business entity has it’s advantages and disadvantages.  It is wise to seek professional advice to assist in your decision-making, and in the setting up of our business structure.  It is also crucial to get your accounting records setup and organized properly at the start of your business.

 

Leader

Filomena Silveira

CPA, CGA, LPA
Partner, Assurance Services

Filomena Silveira

(905) 361-8698

filomena.silveira@bgdgroup.com


Filomena is an Assurance & Advisory Partner at BGD. She is a Chartered Professional Accountant with over 20 years’ experience, servicing clients across a range of industries, such as consumer packaged foods, construction & real estate, manufacturing, mining, retail and professionals. Her diversified and extensive experience includes leading projects at a national Canadian grocery and […]