When is it Time to Incorporate Your Business?

When is it time to incorporate your business?
To Incorporate or not to Incorporate? That is the question.
For most small businesses, the question of if and when the company should be incorporated is one that should be considered at regular intervals.
Many entrepreneurs launch their small businesses initially as sole proprietorships, and then they wonder if they should take the next step and incorporate.
To incorporate means that you are establishing your business as a separate legal entity meaning it pays corporate income tax which is calculated totally separate from the owner’s and shareholder’s personal taxes.

Why you need to talk incorporation over with an expert

It is important to seriously discuss this an expert in the field – your Accountant and or your lawyer instead of just rushing into it without all the facts. The bottom line – make sure you speak with a professional before you make any decision. Your accountant is usually the best person as they are usually involved in your overall tax planning strategy so they see the big picture and can then make the best recommendation for you.
The reality is that there is a lot of misinformation passed around anecdotally and people with no business acumen or understanding of what is involved will seriously recommend incorporation without understanding the full ramifications of it.
What many entrepreneurs don’t realize is that it should never be just an automatic assumption. In fact, if you are just starting your company and anticipate losses in your first couple of years or very small gains, and you have little legal risk, you should probably avoid the high administrative costs that come with incorporating and instead stay as a sole proprietorship.
If you are making enough money from your business to live on, but not much more, and you have no big bank of profits building up, then incorporation may not be the wisest thing to do.

Not just a status to hide behind

Likewise, if you are incorporating simply to protect your personal assets from any legal liabilities, you should read the fine print. Incorporation is not a foolproof plan. Your corporate directors can still be personally liable for debts incurred or for lawsuits filed.
Here’s three good reasons why you should not just rush into incorporation:

  1. It costs money you may not have to incorporate. If you have legal training, you might be able to do it yourself, but for the bulk of small business owners, you will need a lawyer and an accountant and you can see the best part of $1000 – $2,500 gone before you even get started, depending on legal rates where you live and the complexity of the company.
  2. You will need to pay more accountants or bookkeepers over the course of a year and file a lot more paperwork than if you retain your sole proprietorship. For example, you will need a separate tax return for your company, an annual return, (allocate at least $1,000 for that) and the cost of one-time articles of incorporation. You will also pay for notifications of share sales, moves, annual meetings or director changes.
  3. You cannot claim any losses on your personal taxes. If your small business fails, all you can write off is the investment you made personally, not the total sum of the money you lost.

In summary, if the money you make from your company is essentially the money you need to live on, you are most likely better off staying in a sole proprietorship mode, or even as a “self-employed” worker.

High profits change your options

However, if your plan is for growth and significant profits or your business has a high legal risk (i.e. doctors and other health professionals, for example) you should look at incorporation early on.
Here are three reasons to incorporate right from the start.

  1. Your business is a separate legal entity so if you have creditors or are caught up in a legal action against your corporation, it protects your personal assets. However, be aware that it does not exempt you from having to pay things like your taxes owed, any personally guaranteed loans, and your payroll deductions.
  2. As a general rule of thumb your tax rate will be lower. In a Canadian controlled private corporation, after the general tax reduction, the net tax rate is 15%. For Canadian-controlled private corporations claiming the small business deduction, the net tax rate is 10%. Provinces and territories generally have two rates of income tax for corporations as well. The lower rate applies to the income eligible for the federal small business deduction. Many use the federal business limit in their deductions, while others establish their own business limits. This varies dramatically from the personal rate. If you made a great deal of money and filed your profits as personal income, your rate could skyrocket to as high as 46%.
  3. You may personally benefit from your business tax flexibility if you opt to sell your company.

If there is a rule of thumb to be used, most tax advisors suggest that if your small business earns you an income of about $60,000, there is really no advantage to incorporating and the administrative costs will be a lot higher.
But if you move well above that level, it is probably time to have a heart-to-heart with your accountant and determine if you should start to consider incorporation.

Be aware of the different types of incorporation

At that time, you have to determine if you will incorporate federally or provincially. Your choice is linked to whether you will be doing business in more than one province.
If you opt to incorporate provincially, and then your business grows and you expand to even just one more province, you may find yourself facing the additional costs of registering and doing considerably more paperwork before you can take that contract in another province.
To incorporate, you need to have a unique name (the name has to be searched legally and there is a cost for that), you have to submit your proposed bylaws and the names of your charter directors.
You can save the cost of searching to ensure your name is unique by having the government give you a unique number, and create your company as a numbered corporation.
There is no one-size fits all formula. Essentially, it is an issue that you must re-examine periodically as your business grows and your profit mounts.
The ideal way to make your final decision is to have your accountant do the rough calculations on tax due and present a recommendation on which strategy will benefit you most: to stay as a sole proprietorship or to incorporate.
This article should not be taken as tax advice or even business advice. It is meant to provide you will information with the strong recommendation that you speak with your Accountant before you make a final decision.
Thank you for reading. Until next time, take care.
This blog is for you and we hope you will enjoy the content.
Please let us know if there are any specific topics you would like us to address in the future.
Copyright: aihumnoi / 123RF Stock Photo

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Steve Loates

Steve is the co-owner of AIS Solutions and Co-founder of Kninja Knetwork. In 2017, his firm was named Intuit's Global Firm of the Future, the first time the title has ever been awarded to a firm outside of the United States. He has also has been named as one of the Top 10 Influencers in the Canadian Bookkeeping Industry. He has been a small business owner for over 30 years and has helped to develop a number of businesses including bookkeeping, online training, digital marketing, website development, e-commerce and retail. Steve passion is educating and supporting small business and when he is not creating online courses he is delivering workshops and webinars across North America and the Caribbean including presentations at QB Connect, Connected, IPBC, CPA The One and Scaling New Heights.


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