Incorporation: Should My Small Business Take This Big Step?
I meet with various small business owners in Calgary and throughout Alberta who are wondering if they should incorporate. It’s not an easy question to answer because there are many reasons for and against incorporation.
Maybe they’ve heard about being protected from liability. Or that corporate tax rates are lower when compared to personal tax rates. Other owners consider incorporation simply because the sound of it may leave the impression that your company is more secure and organized. This may be a legitimate reason, since some organizations may insist you are incorporated before working with you.
Alas, there are also reasons why incorporation may not be a good fit for you. For many, the most obvious is incorporating costs money and takes time to set up.
To help you determine if you should see Mullen & Company to incorporate a new business idea, or to begin a new chapter for your current business, here are a few things to consider:
Good Reasons to Incorporate
You May be Protected from Financial Obligations
If you are a sole proprietor or partner in an Alberta business you are personally responsible for the debts of the business. If the business fails to pay its debts you will have to pay. With an incorporated business the shareholders typically are not responsible for the debts of the corporation. If the incorporated business fails to pay its debts you as a shareholder normally will not have to pay. Exceptions to this general rule are:
- If you have signed a personal guarantee. (Landlords, banks, and often trade creditors may require you to sign a personal guarantee prior to doing business with them). However, incorporation may protect you from other creditors who loaned your business money without requiring a personal guarantee; and
- If you are the owner of a corporation (shareholder) and also the director of the corporation you will be personally responsible for the payment to the government of GST collected, source deductions from employees, CPP contributions, EI contributions, and wages for up to 6 months.
You May Be Protected from Risk and Liability
Businesses with employees are especially vulnerable to liability due to an employee’s negligence. Incorporating can offer protection in these situations. For example, if you operate a landscaping company and an employee accidentally injures someone with a lawnmower, the courts can’t come to you personally. They can only access the assets within the corporation. (Of course, having insurance for such instances would be wise, as this could save the future of your business.)
One important note: If the owner of the company was pushing the lawnmower in the above example, he will not be protected from liability. Instead, he could be personally responsible for damages caused by his own actions. Again, incorporation doesn’t negate needing appropriate liability insurance, which may protect the owner/director of a corporation in this case.
Optimizing Your Income and Taxes
Changes to Canada’s tax laws threaten to erode many of the tax benefits, but there may still be economic advantages to incorporation. You’ll want to speak to a tax accountant to get details that are applicable to your specific situation. Certain scenarios may still offer financial gains. For example, you may be able to defer paying personal taxes by keeping some profits within the corporation.
Corporations May be easier to sell or transfer
Corporations, unlike people, can live forever. You may want to pass your business to a child or other relative. Or, you may want to court a buyer on the open market. Even if shareholders die or owners change, a corporation can continue. Another option is to sell the assets of your corporation, but maintain the corporation for another purpose.
Taking Advantage of Canada’s Small Business Tax Deduction
Only incorporated business can take advantage of Canada’s small business deduction. This tax law allows you to pay a lower rate of tax on the first $500,000 of taxable income in your corporation.
Attracting Other Business
Some businesses may require you to be incorporated before they will contract with you. Some do this in an attempt to avoid paying EI, CPP and other employee benefits etc.
Reasons Not To Incorporate
Taxes May Be Higher
Depending on your personal tax situation, a very small business may be financially better off staying as a sole proprietorship or partnership outside of a corporation. For example, corporations are not eligible for personal tax credits.
Don’t Over Estimate Your Liability Protection
As discussed earlier, having “Ltd.” after your name is not a bulletproof wall. Personal negligence, guarantees and other situations may still expose you to risk and liability. Incorporation is not a replacement for a good insurance policy.
Incorporating Costs Money and Time
Unlike a small proprietorship, it will cost in the hundreds of dollars to register a provincial or federal corporation. In addition, you’ll need to renew the registration annually. You may also need to spend additional money on accountants and other fees.
Filing an Annual Corporate Tax Return
Your Alberta corporation files a tax return just like an individual person would… except it’s a different return that is far more complex. If you have a simple corporation, you may be able to do this with tax software – which still costs a few hundred dollars each year and your time.
Bringing Your Corporation to a Close Is More Complex
If your corporation comes to a point where it needs to be dissolved, you’ll need to do some extra paperwork and file forms with Canada Revenue Agency, Alberta Registries and possibly the Courts along with a final tax return.
Helping you make the incorporation decision:
These are just a few things to consider when deciding whether or not you should incorporate your business. There are countless other complexities that could come into play. Mullen & Company will be happy to meet with you and discuss your personal scenario. We can offer advice as to what type of corporate structure, if any, would be beneficial for your business.
This blog post is not intended to give full legal advice on any of the above points. Each situation is unique and you should seek personal legal and tax advice before taking this important step.