As a Surrey accounting, tax preparation and bookkeeping firm, we have seen a number of Surrey, Vancouver and Langley businesses come to us to complete their corporate returns, only to discover they incorporated too early to see the benefits. In most cases it is because they heard from friends that being incorporated was the best option. In order to discuss when to incorporate your business, let’s first look at the benefits.
When unincorporated, the CRA considers both you and your business to be one and the same. You are taxed based on the money you earned less your expenses to earn that income. A corporation is a separate legal entity and you become a shareholder and employee of that corporation. Both you and the corporation are required to file income taxes separately.
The benefit of this is that you are only taxed personally on the money you take out of the corporation rather than on all the profit the business made. The corporation is taxed on the money left in the corporation and the tax rate will generally be much lower assuming the business qualifies for the Small Business Deduction. This also gives the added benefit of being able to smooth out your income if your business’s income fluctuates wildly from one year to the next.
As long as your shares have dividend rights, the shareholder is entitled to receive dividends. By issuing shares to your spouse, adult children, or a family trust, the income can be split to reduce overall taxes. This is especially useful when the spouse does not have employment income.
Note: there is talk by Canada’s finance minister of proposing changes to remove this benefit, but nothing is currently in the works as of the writing of this article.
Incorporation generally limits the liability of the owners to the amount the owner invested in the corporation. This protects the owner’s personal assets, such as a house or car, from losses due to lawsuit or financial difficulties of the corporation. However, banks may require a personal guarantee, which would strip the protection for financial difficulties. Also, the courts can “pierce the corporate veil” in lawsuits where there is only one officer, director, and shareholder, and a wrongful or improper act is done.
So, with all these great reasons to incorporate, why wouldn’t everyone do it? The legal and accounting cost to initially incorporate can be quite high. You also now need to file two tax returns (corporate and personal). This is not a DIY tax return for most taxpayers and the cost to prepare a corporate return is much higher than a personal return.
Moving from a sole proprietorship to a Corporation or vice versa can trigger some additional taxes if not done properly. We advise seeking help for these transactions.
So, how do you know when it is time to incorporate? The short answer is, when the benefits outweigh the costs. There is no real benefit if you plan to draw out all profits, can’t income split, and don’t need the liability protection.
The best advice is to speak to a CPA prior to incorporating. If you have any questions about incorporating or if you are looking for a Chartered Professional Accountant to help with your business, Royer Accounting will be more than happy to lend you our expertise. Please contact the tax preparation professionals at Royer Accounting at 604-409-4040 or by filling out a contact form on our website. Our variety of services (tax preparation, bookkeeping, business advisory, and accounting) can take away the stress of dealing with your business’ finances.