Should I incorporate my business?
As Chartered Accountants in Toronto and Mississauga new clients often ask the question of if they should incorporate their business? Tax laws will differ if you operate your business as a sole proprietor as opposed to through a corporation. As a sole proprietor you operate your business as an individual and report your business assets and income through your personal tax return. A corporation, on the other hand, is viewed as a separate legal entity, of which you are a shareholder, and your business assets and income would be reported through your corporate tax return. The decision whether to incorporate your business will depend on the many factors, some of which are specific to your situation. Listed below are some of the general advantages and disadvantages of both approaches.
Advantages of Incorporating:
- From a tax perspective the biggest advantage stems from the flexibility to implement tax planning strategies that can significantly reduce the taxes you pay. For instance, as a shareholder and employee of your business you can save yourself a lot in taxes by effectively achieving an optimal mix of payouts in the form of salaries and/or dividends. In addition, several other tax saving strategies can be implemented (i.e., issuing shares to family members, shareholder loans, etc.) that are not available to sole proprietors.
- In Ontario your business income will be taxed favourably at a rate of 15.5% up to $500,000 (this rate does not apply to passive income such as rental and investment income). Your after-tax business income can be left inside the corporation thereby deferring additional taxes indefinitely. If you decide to take these funds out of the corporation you will be taxed favourably because the tax laws allow you to claim a dividend tax credit. If structured properly, the total taxes you pay will be significantly lower than as a sole proprietor earning your business income at the highest tax rate of 46.41%.
- A corporation allows you as a shareholder to have limited liability. Your personal assets will be protected and only the assets of your business held within the corporation will be at risk from potential lawsuits.
Disadvantages of Incorporating:
- The laws regarding corporations are complex and cumbersome and often require the help of skilled professionals (i.e., lawyers, accountants and tax practitioners).
- Because of their complexity there are more costs associated with setting up and maintaining the corporation.
- Any losses in the business are trapped inside the corporation and cannot be used to reduce the income you generate from other sources on your personal tax return.
Advantages of Sole Proprietorship:
- Relatively simple in comparison to corporations and less costly in terms of setting up and maintaining.
- Any losses in the business can be used to reduce the income you generate from other sources such as employment or investment income.
Disadvantages of Sole Proprietorship:
- The ability to implement tax planning is very limited. As a result, the sole proprietor will pay taxes based on their marginal tax rate. A more profitable business will attract higher tax rates because the income will be taxed in a higher tax bracket. In Ontario any income in excess of $132,000(2012) will be taxed at 46.41%.
- The sole proprietor has unlimited liability from potential lawsuits which means all the business and personal assets of the individual are at risk.
In general, the higher your business income the more advantageous it is to incorporate your business. However, there are advantages and disadvantages to both types of structures. As Chartered Accountants in Toronto and Mississauga we recommended you seek professional advice to help you determine which type of structure is most appropriate to meet your business needs and minimize the taxes you pay. Contact a Chartered Accountant by email at firstname.lastname@example.org or call us at 647-725-2537 to discuss what option is best for you.