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It's Your Money  

Should you incorporate?

If you’re like most unincorporated small business owners, you’re likely contemplating these thorny questions:

  • Should I incorporate?
  • If so, when’s the best time?
  • If not, why not?

The simple answer you often hear is, incorporation is always good because it delivers terrific tax benefits while creditor-proofing your personal finances.

But it is not that simple.

Whether to incorporate raises a diverse array of issues, many of them having to do with:

  • The length of time you’ve been in business
  • Your personal cash-flow needs
  • The relative profitability of your business
  • The personal and corporate tax rates in your province.

Let’s take a closer look at how these and other issues might affect your decision.

If you need all the profits from your business to support your personal cash-flow needs, incorporation may not be for you. The cost of setting up and maintaining the corporation could outweigh the tax benefits.

But when your financial position allows you to retain some of your business profits inside the company, incorporation could deliver significant tax advantages.

The money retained in the company can be used to grow the operations or invest in other non-related investments.

When it comes to taxes, incorporation can be a double-edged sword.

If you’re in the initial stages of your business, it’s usually advisable not to incorporate because losses incurred by an incorporated business can’t flow through to shareholders. In those early stages, you’re generally better off being able to use those losses personally against other income.

Once your business becomes profitable, incorporation can provide tax advantages.

If your business earns active business income (income earned as a direct result of the operation of the business as opposed to passive income earned, for example, by holding other investments through the corporation) you may gain an immediate tax break (in some provinces) and the opportunity to defer part of your tax payment.

A Canadian-controlled private corporation’s active business income is taxed at a relatively low combined federal/provincial rate of 9–15%, depending on the province in which you’re doing business.

The lower rate is generally applied on the first $500,000 of active business income.

Even though shareholders must pay a second level of tax once the after-tax income is paid out as dividends, this second level of tax is applied only when the dividends are paid.

You can control when you pay these taxes – and potentially reduce your tax bite – by choosing to declare dividends in years when your personal taxable income is lower.

Income splitting has historically been one of the big advantages of incorporation, but it has become more complicated since the expansion of the Tax on Split Income rules, but opportunities still exist.

Income splitting is still possible, particularly if your family members work in your business or your business is not predominantly earning its income from providing services.

There is also an ability to income split with a spouse once the business owner/shareholder reaches age 65, so retirement planning can factor into the decision to incorporate.

Incorporation can limit your liability because corporate assets and personal assets are kept separate and corporate creditors can only go after assets owned by the corporation.

But banks and other corporate suppliers often require small business owners to personally guarantee any corporate liabilities and directors of a corporation may be liable for many types of unpaid debts (including outstanding income tax, GST/HST, PST and employee source deductions) so incorporation may not protect you from all creditors.

Your incorporated business can choose a fiscal year spanning any 12-month period.

You can select a fiscal year-end that coincides with business or cash flow peaks (making tax payments easier) or when corporate expenses are higher (potentially reducing your corporate tax hit).

The life of an unincorporated business usually ends with the life of its proprietor. But a corporation can continue to exist indefinitely, which is why corporations are often used for estate planning purposes.

It is important to take steps so that after your death the business remains profitable with sound management provided by family members or others

If after assessing the pros and cons, you’re still not sure if incorporation is right for you, seek out the guidance of a financial professional to help you make a decision.

This article is written by or on behalf of an outsourced columnist and does not necessarily reflect the views of Castanet.

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About the Author

Brett Millard is vice-president and a member of the executive leadership team at FP Canada, the national professional body for the financial planning industry. A not-for-profit organization, FP Canada works in the public interest to foster better financial health for all Canadians by leading the advancement of professional financial planning in Canada. 

He has worked in the financial advice industry for more than 15 years and is designated as a chartered investment manager (CIM) and is a certified financial planner (CFP).

He has written a weekly financial planning column since 2012 and provides his readers with easy to understand explanations of the complex financial challenges they face in every stage of life. Enhancing the financial literacy of Canadian consumers is a top priority for Brett and his ongoing efforts as a finance writer focus on that initiative. 

Please let Brett know if you have any topics you’d like him to cover in future columns ,or if you’d like a referral to a qualified CFP professional in your area, by emailing him at [email protected].

 



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The views expressed are strictly those of the author and not necessarily those of Castanet. Castanet does not warrant the contents.

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