To Incorporate or Not?

There is no easy answer to this question, but we will try to keep it simple. First of all, this short article is for Canadian small business owners – and not for the folks who run big businesses. And we assume that you are either just starting your business or have been in business for a couple of years.

Incorporating has its advantages and disadvantages. Pros generally include limited liability, better access to capital, unlimited life span, lower taxes, potential for income splitting with family members and higher profits when you sell your business.

And of course you won’t get those advantages for free. The cons of incorporating include higher start-up and annual costs, and in addition, limited liability may not be as limited as you wish.  You will also have to learn new laws under the Corporations Act and understand responsibilities of Directors. Directors can and do sometimes get sued (being a shareholder carries much smaller risk, and is normally limited to the shareholder’s investment in that corporation).

The simple rules below will help you determine if you need to incorporate your business. Needless to say, they are not carved in stone, and have some exemptions.

Rule#1: Every person who starts a business should not incorporate automatically. In many cases it will only increase costs and paperwork. And often it is much better to spend $700 – $1,000 on a new computer than to give this money to lawyers and other professionals.

Rule#2: In most cases it is not a good idea to incorporate your business unless it starts showing a consistent profit. As you know, losses from sole proprietorship can be deducted from your total income on your personal tax return, while you cannot do the same with corporate losses.

Rule#3: Consider incorporation when you stop running your business alone and hire you first employee.

Rule#4: Incorporate your business when it earns more money than you need for living. Incorporating may allow for income splitting (dividends paid to other adult family shareholders) and tax deferral opportunities.

Rule#5: Incorporate your business if it is profitable, and you are planning to sell it in the future. For example, if both spouses are shareholders the family can get up to $1,500,000 tax free when the business is sold.

So if you are not sure whether to incorporate and feel a bit confused, don’t blame yourself – the whole issue is pretty complicated. Better talk to your accountant.