Time to incorporate?

There are many reasons one might decide to incorporate an existing business. These reasons include both tax and non-tax reasons. The most common non-tax factor for incorporating would be to limit the exposure that creditors and other claimants have against your personal assets that are not part of your business. If the limitation of legal liability is the main reason for incorporation it is important that the advice of a lawyer be sought. This article is intended to briefly cover the tax related advantages that come with incorporation, as well as some of the disadvantages.

Some potential tax benefits that are gained when a Canadian business is conducted through a corporation include:

Lower Tax Rates - Unlike business profits earned inside a proprietorship that are subject to the proprietors marginal tax rate (which can be as high as 43.7% in BC), the first $500,000 of qualifying profits of a Canadian Controlled Private Corporation are subject to taxes at a rate of only 13.5% in BC.

Deferral of Tax - To the extent that after tax dollars can be left behind and reinvested into the business this lower tax rate provides a significant deferral of the taxes that would be paid if the income was not earned by a corporation.

Non-Taxable Capital Gains - When the Lifetime Capital Gains Exemption can be utilized the business owner may have the ability to sell the shares of the company for up to $750,000 without paying any tax on the proceeds.

Income Splitting - A flexible corporate share structure can allow profits to be allocated to family members in a lower tax bracket which can create significant tax savings.

Succession - As the business grows children and other family members may become involved in the business. When a corporation is used it becomes significantly easier to transition new generations into the business as the older generations retire.

Some of the disadvantages that can result from incorporation include:

Trapped losses - Often new business will not operate at a profit in their early stages. Losses inside a corporation cannot be applied against the owner’s other sources of income. Losses realized by a proprietorship can be applied against the owner’s other sources of income.

Taxable Shareholder Benefits - Corporations are subject to specific rules governing the taxation of shareholder benefits, such as shareholder loans or the personal use of company cars and other company assets. Ensuring these rules are complied with requires the assistance of tax professionals.

Initial Costs - For an existing business, the transfer of the proprietorship’s business to a corporation may be a taxable transaction that the owner will have to pay tax on. This can be avoided if the correct income tax elections are completed and filed but that process requires the assistance of tax professionals.

Increased Reporting - A corporation will normally have more tax reporting requirements and as such the annual cost of professional fees to comply with these requirements can be more than the costs associated with maintaining a proprietorship.

Whatever your reasons are for wanting to incorporate it is important the benefits exceed the costs. To understand and quantify the benefits versus costs the assistance of a qualified professional should be sought.

This article is written by or on behalf of an outsourced columnist and does not necessarily reflect the views of Castanet.