Incorporating My Small Business
Many small business owners, proprietors, ask all of the time when they should incorporate their businesses. The answer is not that simple, with many factors to consider prior to making the leap to incorporate.
When you incorporate your proprietorship or small business, you are separating yourself from the newly formed legal entity (Corporation). As a result, your creditor can not make claims against your personal assets (house, cottage, investments etc.) for any unpaid bills or debts unless you have personally guaranteed those debts. Otherwise, they can only make claims against the assets of the corporation.
On the other hand, as a proprietor your personal and business finances and assets are mixed together and you are personally responsible for all debts. Obviously, this makes your personal assets fair gain if you do not meet your business debt obligations.
When to Incorporate
In my opinion, the answer is obvious – when your business is making significant profits and you are saving the money in the business rather thank taking it out to pay personal expenses. In a sole proprietorship, your business income is your personal income and you are taxed on the full profit at your marginal tax rates. Conversely, corporations also pay taxes on the net profit for the year, but a far lower tax rates that you would pay personally.
As the example clearly indicates, there is a substantial difference in tax and net amounts remaining between being taxed as a proprietor and a corporation. As a proprietor your tax payable would be approximately $28,000 versus the $4,880 corporate income tax payable plus approximately $11,400 on your salary, a total of $16,280 combined. However, the income tax is not completely eliminated on the $11,720. You will have to pay tax on it once you personally take it out as salary or dividends.
What are The Draw Backs
There are a number of costs involved in incorporating your proprietorship. First, there is the cost of having a lawyer incorporate the company. Second, you have to maintain a full set of accounting records which involve monthly bookkeeping, preparation of payrolls etc. Thirdly, you must prepare annual financial statements and file corporate income tax returns with CRA.
Lastly, is cost to transfer the assets from the proprietorship to the corporation. This is normally done by filing a Section 85 Election on Disposition of Property by a Taxpayer to a Taxable Canadian Corporation with CRA (form T2057). The transfer is completed at the fair market values of the assets being transferred, including goodwill.
Please read my article on Transferring Assets to a Taxable Canadian Corporation.
This course material deals with complex matters and may not apply to particular facts and circumstances. As well, the course material and the references contained therein reflect laws and practices which are subject to change. For these reasons, the course material should not be relied upon as a substitute for specialized professional advice in connection with any particular matter. Although the course material has been carefully prepared, neither the author, and/or firm, nor any persons involved in the preparation and/or instruction of the material accepts any legal responsibility for its contents or for any consequences arising from its use.