A question that is commonly asked is whether or not to incorporate. There are advantages and disadvantages to incorporating, and one needs to make sure that the advantages outweigh the disadvantages for your specific situation.

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Advantages

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• Limited Liability—An incorporated company is its own legal entity. This means that the corporation can acquire assets, obtain a loan, enter into contracts, and sue or be sued. Incorporation can protect you against personal liability. If someone goes after the company for debt repayment, they are limited to the company assets and cannot make a claim against your personal assets (i.e., houses, vehicles, etc.). The amount that you have at risk is limited to what you have invested into the company.

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It is important to keep in mind that some financing agreements require a personal guarantee. In these cases, the personal guarantee negates this protection. Be mindful of your goals and intentions of the corporation when entering into new contracts.

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• Income Splitting—Income splitting used to be a big advantage to incorporating your business. This allowed you to pay out dividends to lower-income family members (i.e., a spouse or children) to enjoy the tax savings of each member’s respective tax rates. The introduction of the TOSI rules (Tax on Split Income) has significantly changed the tax regulations, and it is important to note that there is little opportunity for income splitting now.
• Tax Savings and Tax Deferrals—Corporations that qualify for the small business deduction can enjoy a significantly lower rate of tax. This provides the opportunity to invest more after-tax dollars back into your company. Another advantage is the ability to plan when you withdraw funds from the company. Being mindful of your personal tax rate can help you decide when and how much to take in salary and/or dividends.

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Again, there is some discussion around this advantage that needs to happen, as those tax advantages are primarily enjoyed by those who leave money in the company as opposed to withdrawing the excess funds.

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• Lifetime Capital Gains Exemption—If your company is a qualified small business corporation, then it can qualify for the Lifetime Capital Gains Exemption. This exemption allows you to sell the shares of your corporation and enjoy a tax-free gain of up to $866,922. This is a significant advantage if you think that you might sell your business in the future.
• Continuation—Since the corporation is a separate legal entity (as we discussed above), it continues after you pass away. This can be an important consideration if you want the business to continue for years to come. If you own a corporation, this should become a critical part of your estate planning.

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Disadvantages

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• Incorporation Costs—There are costs involved with setting up your corporation whether you use a lawyer, go to a registry office, or set up your own company online. The costs of these options vary and will come down to your knowledge and comfort level of doing it yourself vs. hiring a professional. Ensuring that your company is set up properly can help to save headaches in the future, but this is something that comes at a cost.
• Annual Costs—In addition to the initial setup, there are annual costs when it comes to filing your annual return with corporate registries and accounting fees to have your corporate return filed, as well as any other required return filings (i.e., GST, T4/T5, WCB, etc.). These annual costs vary significantly depending on what is involved in the year-end preparation. There are many factors that will impact the cost of completing your year-end, including bookkeeping, filing requirements, etc. Discussing this ahead of time with your accountant can help prepare you for what to expect come year-end.
• Losses—It is common for companies to incur losses in the first few years of operations. You are spending money on start-up costs (i.e., furnishings, programs, advertising), and your revenues are typically lagging behind. When you incur losses as a sole proprietor, these losses can be applied against other sources of income. Conversely, when you incur losses as a business, these losses carry forward and reduce future income. Although you get a benefit from the loss either way, the losses against personal income are more immediate and can reduce income that is taxed at a higher rate.

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Discussing your business goals with your accountant, along with analyzing your current tax bracket is a great starting point to determining if incorporation is right for you.

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Conclusion:

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If we look at the above discussion, it appears that incorporation trumps sole proprietorship based on the number of advantages. It is important to remember that these advantages do not apply in each situation. Sometimes the business owner’s goals and operations can reduce or completely eliminate certain advantages.

Discussing your business goals with your accountant, along with analyzing your current tax bracket, is a great starting point for determining if incorporation is right for you.

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