Financially Speaking

If you’re a small unincorporated business owner or a professional whose regulatory body allows incorporation, you’ve probably given the potential benefits of incorporating a great deal of thought. The most often cited benefits of incorporation are a more advantageous tax structure and creditor-proofing personal finances. But there can be drawbacks. Here are some of the issues to consider when making your ‘incorporate or not’ decision.

Cash Flow If you need all of the profits from your business to support your personal cash flow needs, incorporation may not be for you because the cost of setting up and maintaining the corporation could outweigh any tax benefits. On the other hand, if you are financially able to retain some profits inside the company, you could derive significant tax savings.

Taxation Vexation If you are just starting your business, incorporation should probably wait because losses incurred by an incorporated business can’t flow through to shareholders. In the early stages of your business, you’re likely better off using losses personally against other income. Once your business begins earning ‘active business income’ (income earned from your business operation, not, for example, from other corporate investments) you may gain an immediate tax break (in some provinces) and the opportunity to defer part of your tax payment.

Creditor-proofing Personal Assets Corporate creditors can only go after assets owned by the corporation, but banks and other suppliers often require small business owners to personally guarantee corporate liabilities and corporate directors may be liable for many types of unpaid debts such as outstanding income tax, HST, GST and employee source deductions. Incorporation may provide some creditor protection, but only if properly structured, so speak to an advisor to ensure you are protected.

Other Potential Advantages of incorporation

• Income-splitting to reduce taxes by making your spouse or adult children shareholders – dividends will be taxed in their hands – or employing them as long as the remuneration is reasonable for the work performed.
• Deferring certain expenses. For example, you can report employee bonuses for tax purposes before year-end but actually pay out the bonus money after year-end.
• Leaving assets in the corporation where they will continue to grow on a tax-deferred basis until you choose the withdraw them.
• Creating a registered pension plan and tax-deductible group health and life insurance plan for you and your employees (which could include family members).
• Choosing a fiscal year spanning any 12-month period. Select a fiscal year that coincides with business or cash flow peaks or when corporate expenses are higher (potentially reducing your tax bite).

Incorporating a business comes with costs – from initial setup and legal costs to ongoing requirements for tax returns and corporate resolutions – and other legal requirements. But if you think incorporation may be right for you, speak with your legal and tax advisor and professional advisor before you do.