One of the most common questions that the small business owner has is whether they should incorporate their business. It is question that is difficult to answer as it depends on your individual needs, financial capacity, and the size of your company. The following are some of the advantages and disadvantages to incorporating your business.

ADVANTAGES

1. Tax Deferrals & Access to the Small Business Deduction

Arguably the best reason to incorporate is because of the tax deferrals it brings. The corporate tax rate is generally much lower than the personal tax rate. Corporate tax rates at the federal level as of 2012 were 11% on taxable income up to $500,000. The lowest tax personal tax bracket starts at a 15% tax rate as of 2012. The rate escalates as income reported goes up.

Therefore, the key to taking advantage of these tax deferrals is to not draw profits out of your company beyond what you need to live within your means. In Canada, there are 4 escalating tax brackets. The more you draw out company profits, the higher the tax bracket you are pushed into. Therefore, you would ideally want to reserve drawing out company profits until a later time when it is most tax advantageous for you to do so, depending on what tax bracket you fall under.

Under ideal conditions, you could essentially create a retirement plan for yourself out of your company.

2. Access to the $750,000 Capital Gains Exemption Limit

In Canada, when you sell your incorporated business, the proceeds from the sale of your business’s shares are generally tax exempt up to $750,000. If you sold a business that was not incorporated, you would not get this tax break as the proceeds could be broken down into several different taxable categories.

3. Liability Protection

Another advantage to incorporation is with regard to liability. In the event the company is taken to court, the incorporated company would be liable for any damages. However, your personal assets such as your home are protected.

If you didn’t incorporate and chose to continue running as a sole proprietorship, then you would personally have and unlimited liability and your personal assets such as your home are not protected.

 

DISADVANTAGES

1. Losses Can Be Trapped In The Corporation

If Canada, if you incur losses within your company over a period of time, those losses are carried forward and applied to future income positions of the company. However, while this rule does apply to both personal and corporate taxation areas, there are limitations.

Generally, business losses for the unincorporated company can be applied against future income, even other employment income. The same cannot be said for the incorporated company. Unapplied losses can only be against future business income only. Hence, if you are no longer in business you may lose that tax benefit.

2. Shareholder Loan Debit Balance Issues

Generally speaking, there is a tax advantage to incorporation as discussed above. However, without the right amount of planning you could potentially overtax yourself. This situation can occur if you draw larger than normal sums of money from your corporate bank accounts. If you are incorporated, generally any draw you make in cash is considered remuneration to yourself and will either need be cleared with declaring a wage and(or) dividend and reporting it.

3. Additional Compliance Paperwork

It should come as no surprise that additional compliance paperwork is required for the incorporated company. Not only do you have a corporate tax return to file, you also have to make annual filings with Alberta registry as well as maintain a minute book.

4. Incorporation Fees

Sometimes, incorporation can be costly. You can either incorporate on your own or with assistance from a professional. The later part could prove to be slightly costly depending on your requirements. You may also have to be worried about any association membership requirements as well if incorporating. Generally speaking, it should be an easy process.

5. Removal of Assets

Removing assets or money from the corporation triggers personal tax consequences.

 

If you would like more information on the above we would gladly be able to assist you with your needs.