Why Should I Incorporate?
One question clients or someone looking to start a business asks me is why should they incorporate? Are there any benefits to operating as a corporation?
Incorporation or incorporating your business is just a fancy term for a structure that holds your business/assets. The term “incorporate” is actually a combination of corpus (latin for “body”) and in (latin for “into”). Incorporation literally means “form into a body”.
There is no fast and easy answer as everyone’s situation is different. I’ll go over why someone would want to incorporate vs. the downside of incorporating your business in this post.
Incorporation benefits
Small business deduction. The Canadian government allows corporations that are carrying on an active business in Canada access to what is called the small business deduction (if it is a business carrying on investments, this won’t qualify). This deduction reduces the amount of taxes that a business would have to pay. Anything below $500,000 in income would be taxed at essentially 12% in Ontario and anything above $500,000 is taxed at 27%. The highest personal tax rate in Ontario is 46%. This represents significant tax savings for incorporating. These tax savings can then be used to invest in your business. Incorporating is a tax deferral strategy as once you pull the money out personally, you will have to pay at your marginal tax rate.
Creditor proofing. Incorporating your company restricts your personal liability to only the debts of the company. Should creditors come after the business, they can’t come after you personally (however, if you own a professional corporation – a topic for another day – someone can still go after you for personal professional liability). Some businesses set up another company (a holding company) that holds their investments and pays the excess cash from the operating company into the holding company, as a way of “creditor proofing”, should the operating company become exposed.
Lifetime Capital Gains Exemption. If you sell your business, you could potentially qualify for what is called a lifetime capital gains exemption. In 2024 it is equal to $1,250,000. This means you are exempt from tax on the first $1,250,000 of capital gains on sale of your business. It is a pretty big deal for small business owners as this sale usually helps fund their retirements. The more dollars in their pockets the better.
Flexibility. Having an incorporated company provides you, the shareholder, with flexibility in terms of how much to pay yourself. If the business earns $300,000 and you only need $60,000 for expenses in the year, you can just pay yourself $60,000 as a wage or dividend. The remaining $240,000 would be left in the company and taxed at lower rates. What’s more is the $60,000 is now deductible to the company as a wage expense but not if it was paid as a dividend.
Income splitting. This was a big advantage prior to 2018 when the law changed. Business owners could pay dividends to their spouse, who would then report the income at a lower rate if she was not working. Now, there is TOSI (tax on split-income) which makes income splitting quite hard. If you pay a dividend to a family member who is not active in the business, they must report it at the highest personal tax rate.
Other. You come across more professional if you have an actual incorporated business to potential clients/customers. It conveys that you are not just a small time operator.
Incorporation disadvantages
Set up costs. If you are engaging a lawyer to help you incorporate, it could set you back a couple thousand dollars. If you choose to do it yourself, it will be a few hundred dollars.
Ongoing professional fees. Every year your numbers need to be input into an accounting system by a bookkeeper and then an accounting firm will provide you with financial statements and the annual tax filing. If you don’t do these yourself, the cost starts around a few thousand dollars and goes up the more complex and time involved.
Administrative burden. Businesses have separate filing deadlines than what is required for personal tax returns. There is the T2 corporate tax return, HST returns, payroll slips to be filed, legal filings with the government and potentially more. The paperwork for a year can sometimes represent a thick chapter book.
So Why Should I Incorporate?
You should usually incorporate when your business generates profits over and above your necessary living requirements. If you don’t need all the money that is being taxed at high personal rates, you should think about incorporating and take advantage of the 34% tax deferral. This also means you have a sustainable business which indicates it could be a good time.
DISCLAIMER: The articles posted on TaxCrunch should not be considered specific advice to anyone readying. Please reach out to a professional advisor to seek guidance on any issues mentioned in this post before acting upon anything written here. All posts are time sensitive to what is law at the time written and are subject to changes in legislation.