There comes a time when many, if not all, entrepreneurs are confronted with the difficult decision of whether to incorporate.
There are a number of advantages to incorporation, such as insulating your business risks, protecting personal assets and enjoying a lower tax rate. It makes absolute sense to incorporate if you are earning more income than you need and want to defer paying tax on the excess income until a later date.
There is a downside to incorporation and this is where many entrepreneurs find themselves in a quandary. For example:
- Legal and accounting fees with incorporation can cost thousands of dollars.
- A corporation is a separate entity and so the money in the corporation is not your money.
- You must draw a salary or a dividend.
- Incorporation requires significantly more paperwork and separate tax statements for the company and your personal income taxes, adding further cost.
- You can only make RRSP contributions using your salary.
If you are a sole proprietor with little at risk and you are earning just enough to live on, the additional cost of incorporation may not make sense. In fact, in the start-up stage you want to utilize your start-up losses against your income.
By incorporating, you can:
- Determine when you receive your personal income, which means you could draw your income when you are in a lower tax bracket.
- Enjoy a lower corporate tax, which is calculated at a rate of 19 per cent on the first $500,000 of taxable income. That is much lower than the 46.41 per cent a sole proprietor would pay on personal income over $124,000.
- Pay any business debt with corporate after-tax dollars rather than personal after-tax dollars.
- Split income with your spouse and children involved in the business.
- Realize a $750,000 capital gains exemption if you sell the business shares as an active corporation.
- Protect your significant personal assets that could be at risk.
- Plan your estate more effectively. You can freeze the value of a corporation today and pass on future growth to your spouse or children, thereby fixing your tax liability with the corporation.
As you weigh the pros and cons of incorporation, remember to walk before you run.