When is the right time to incorporate?
Incorporating your small business
As a small business owner, once your business grows, you are likely to face the decision of whether or not to incorporate. An experienced small business accountant will advise you to base your decision to incorporate on a number of factors, tax and economic related.
- An incorporated business is a separate legal entity distinct from its shareholders. A corporation will continue after the owner’s death, therefore facilitating the business succession;
- Liability is limited to the company's assets. However, small business owners are often required to provide personal guarantees for bank debt, thereby extending the risk beyond business assets;
- Additional costs are associated with incorporating a small business, such as incorporation costs and the ongoing maintenance and compliance tax, accounting and legal fees;
- Directors of an incorporated business can be liable for debts of the corporation such as payroll withholdings and GST.
- The most important tax advantage of incorporating a small business is the income tax deferral. Because the corporate rates in Canada are lower than personal tax rates, Canadian controlled private corporations (CCPC) pay a reduced tax rate on the first $500,000 of active business earnings. The "small business rate" ranges from approximately 11% to 19%, depending on the province of operation (14% in Alberta). When we compare this with the top marginal personal tax rate, 39% in Alberta, this amounts to a potential tax deferral of $125,000 on the first $500,000 of earnings.
The deferred tax is usually paid when the after-tax corporate earnings are paid to the shareholders by way of dividends. However, the longer the corporate earnings remain in the corporation, the greater the benefit associated with the tax deferral.
- If your small business is providing services that would normally be provided by an employee (incorporated employee), consider the personal service business rules;
- Availability of the lifetime capital gains exemption ($750,000) on the sale of shares of a qualified small business corporation (QSBC);
- Flexibility in the character and timing of remuneration (dividends or bonuses paid to shareholders);
- Possibility of income splitting by having family members subscribe for shares of the corporation and receive dividends. This is not recommended for minor children because income distributed to them is subject to the top marginal personal tax rate. Some accountants recommend using a family trust that will hold the shares on behalf of the beneficiaries - usually family members;
- Reducing the tax liability associated with the deemed disposition of the small business shares on the shareholder’s death by effecting an estate freeze;
- Any losses generated by an incorporated business cannot be used by the shareholders against their personal sources of income. An astute small business accountant will recommend that startup operations, which may operate at a loss for the first years, start out as unincorporated businesses and incorporate after the small business begins generating profits.
Your trusted Chartered Accountant provides services regarding business incorporation to doctors, dentists, small business and contractor clients.
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- When is the right time to incorporate?