Should You Incorporate?
If so, then when is the right time to incorporate?
“I heard I can save taxes if I incorporate, is it true?”
One of the most common questions I get from my friends is whether they should incorporate. The other day, my boyfriend who is now self-employed also asked me over dinner when he should incorporate (oh yeah, so romantic).
Before incorporation
Most people start out as a sole proprietor. A sole proprietor is an unincorporated individual, and it is the simplest business structure. For example, a self-employed consultant who is not incorporated is a sole proprietor.
What does it mean to “incorporate”?
To incorporate, it means to legally create a corporation entity. Once you are incorporated, it means you will have a company that is legally separate from you personally.
Advantages of incorporating
Asset protection – If your business is at a high risk of being exposed to legal liabilities (may be sued someday), then you should consider incorporating. If you operate the business personally, you may personally liable for legal damages. But if you incorporated, then you may be able to limit the liabilities to the company’s assets.
Enhance credibility – Customers and vendors often perceive corporations as being more stable than unincorporated businesses. Having “Inc.” or “Corp.” after your business name conveys credibility and stability.
Potential tax deferral and planning opportunities – In Canada, small business corporation tax rates are lower than personal income tax rates. If you plan to keep the profits in the company, then corporate taxes can be deferred for as long as income is kept in the company. Also, if certain criteria are met, a Canadian resident has a lifetime capital gain exemption, which allows qualifying small businesses in Canada to sell at a gain up to $883,384 on a tax-free basis.
Access to capital – As a corporation, you can raise money by issuing share capital.
Downsides to incorporating
Administrative burdens – Each year, you will need to file a corporation tax return (in addition to your personal tax return) and legal filings with the government for your company.
Incorporation can be costly – Depending on the shareholder structure and your business needs, legal fees to incorporate can be costly.
Limitation to operating losses – As a sole proprietor, business losses can be deducted against your other personal income. Operating losses of a corporation are limited to be applied against income of that corporation; however, company operating losses can be carried forward to future income or back up to three years to reduce taxes.
Dissolving a corporation is more difficult – If you choose to close down your business operated as a sole proprietor, it is much simpler. To dissolve a corporation, you will have to get your corporate lawyer to file a dissolution resolution to the government authorities. You will also need to file your final tax returns for the corporation.
Now here is the real question… should you incorporate?
The answer is – it depends. Whether you should incorporate depends on the nature of your business and your personal cashflow needs.
If you are concerned about legal liabilities, then it makes sense to incorporate to protect yourself.
If currently you need all the business profits for your personal needs (you pay all the profits to yourself right now, and there is not much left over to be reinvested for the business), then it may be better to wait until the business income exceeds your personal cash needs to incorporate.
As you can see, there are many factors to consider before incorporating. If you are still uncertain about whether you should incorporate your business, send me a DM and I’d be happy to answer your questions!