Should I incorporate my business? As accountants, we get this question all the time and the answer is never as simple as it seems. Incorporating has many benefits but may not be the solution for everyone.
What are the main benefits of incorporating a business?
Tax Deferral
One of the main benefits of incorporating is the deferral of tax.
Currently, a Canadian Controlled Private Corporation (“CCPC”) carrying on an active business, operating in Ontario, pays a combined corporate tax rate (Federal and Provincial) of 12.2% on the first $500,000 of net income. Alternatively, if the income is earned personally (instead of in the corporation), the tax rate can be as high as 53.53%. Please note that these tax rates only apply to active businesses (and not passive investments – i.e., a corporation holding an investment portfolio).
Therefore, if the active business generates more income than required personally, you can leave behind excess profits in a corporation, resulting in a large tax deferral (approximately 41%). These excess profits can be reinvested into capital to grow your business or re-invested into corporate owned investments that can earn passive income or capital gains.
Tax-Free Sale of the Business
In circumstances where a business is a sellable business, it may be beneficial to hold the business inside a corporation.
An individual, resident in Canada may be able to sell qualifying shares of a CCPC without any (or minimal) income tax implications by utilizing their lifetime capital gains exemption (“LCGE”). More specifically, an individual that has not used the LCGE in the past, can incur a capital gain of up to $892,218 on the sale of qualified small business shares, without any income tax implications. The current LCGE limit for 2021 is $892,218 and is adjusted for inflation in future years. (*Please note that there are stringent criteria that must be met to ensure the shares of the corporation qualify for the LCGE. Also, a minimum tax may apply, which is beyond the scope of this article.*)
This would not be the case if the business was operated as a sole proprietorship.
Liability Protection
In circumstances where there are not significant tax benefits of incorporating, there may be other reasons for doing so, such as liability. We recommend speaking to your legal counsel to fully understand the potential liability protection.
So why not incorporate every business?
Incorporation may not be for everyone.
For example, in situations where all the funds earned by the business are needed for your cost of living and there is very little liability risk, incorporation may not be practical. It is important that you speak to your advisors, prior to incorporating.
Incorporation can potentially have several drawbacks associated with it, such as:
· increased legal costs (both for incorporating and ongoing);
· administrative burden (tax filings); and
· business loss utilization limitations (cannot offset corporate losses against personal income).
Furthermore, not all individuals are suitable to incorporate (i.e., employees of companies). An “incorporated employee” can result in significant and punitive tax consequences.
Therefore, prior to incorporating, some of the questions you should be asking yourself are as follows:
Is the business an active business (i.e., a hair salon)?
What are my family’s financial needs?
Does my business have significant liability risk?
Is my business a sellable business?
Do I want to transition the business to other family members (estate planning)?
To summarize, many of the benefits to incorporating only apply to active businesses, such as a mechanic shop, hair salon, legal office, etc. Passive businesses, such as a real estate portfolio corporation (with less than 5 full-time employees) or a portfolio investment business does not have the same tax benefits but may offer liability protection. It is imperative that you speak to your advisor, prior to determining whether you should incorporate any business.
VC Partners LLP is a boutique accounting, tax, audit, and consulting firm, located in the GTA.
For any questions, please reach out to one of our team members.
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