By: Robert Catalano
As an owner of a sole proprietorship, you may be reading or hearing a lot about the benefits of incorporating. While it’s true that incorporating is good for some, not all businesses will necessarily benefit from this move.
What should you ask yourself when considering incorporation?
Is your business profitable enough?
Generally, in the first few years of operation, a business generates losses due to high start-up costs and/or the cost of building a sales base. As the owner of your business, as long as you’re not incorporated, you can use your business losses to offset other sources of personal income, assuming the business is not a “personal endeavour” (i.,e hobby). If your business is incorporated, any business losses must be applied against the corporation’s income and cannot be used to offset personal income. Corporate business losses, however, can be carried back 3 years or forward for 20 years before they expire and become worthless.
Is the business producing more income
If so, then incorporating may allow you to split income (i.e pay dividends to other adult family members who are also shareholders of the corporation) and take advantage of tax-deferral opportunities, since active business income earned in a corporation is taxed at a much lower rate than business income earned personally. Little to no benefit is gained from distributing all of the company’s profits, whether by salary or dividends, to the owner-manager.
Will you really pay lower taxes as a corporation?
Incorporated small businesses enjoy greatly reduced federal and provincial tax rates on the first $500,000 of “active business” income. To illustrate, for 2012, the combined federal and provincial corporate tax on income subject to the small business rate ranges between approximately 11% and 19%. The top marginal personal tax rate is between 39% and 50%, depending on your province of residence, which applies to taxable income over $125,000. The lower tax rate allows an incorporated business to reinvest more capital. However, this is only a tax deferral. When the funds are ultimately paid out of the corporation, either by way of dividend or salary, the business owner must pay.
Are you considering retiring or succession planning?
Incorporating your business can reduce or defer your taxes as part of your retirement plan. Two common methods used are:
1. Ensure your business qualifies as a small business corporation
A portion of any gain on the sale of the shares could be exempt from tax by way of the capital gains deduction. Up to $750,000 of the capital gain can be sheltered using this exemption. The $750,000 capital gains exemption is only available on the sale of qualified shares of a corporation (i.e. it is not available to a sole proprietor selling the assets of their business).
2.Freezing your estate
This is a process whereby the future growth of a company is transferred to other family members, but the control remains with the original owner, if the owner so chooses. This may enable you to:
Transfer future tax liability on the growth of the company to your beneficiaries.
Multiply the use of the $750,000 capital gains exemption for small business owners.
Since a corporation is viewed as a separate legal entity, the creditors of the corporation generally cannot seize the personal assets of the owner manager unless the owner-manager gives personal guarantees on the loans of the corporation.
A corporation can offer benefits that are not available to sole proprietors, such as group disability, health insurance and a registered pension plan.
A corporation is required to file its own tax returns and hold annual shareholder meetings. This leads to higher annual administration, legal and accounting costs.
Personal use of corporate funds
As a sole proprietor, all the business income you earn is taxed in your hands annually; therefore, you can use the after-tax profits however you wish. On the other hand, if you incorporate your business, after-tax profits belong to the corporation, and as such, you cannot use corporate funds for personal expenses unless you first take money out of the corporation using a legitimate method, such as paying yourself a salary, bonus or dividend.
Please join me on November 27th at 6:30 pm for a FREE seminar for small business owners and medical professionals regarding Business Incoporation. The event will be held at the RBC Branch at 5701 Monkland. Please RSVP by contacting Nathalie Im at 514-340-3898.