We often get this question: “Should I incorporate my business?”
Unfortunately, many people decide to incorporate without considering the consequences or based on unqualified opinions from “This guy I know….” When considering incorporating, be sure to understand what you’re getting yourself into before pulling the trigger. Not setting things up correctly or failing to stay compliant can be costly mistakes.
For the sake of this article, we are only discussing these matters in very general and basic terms relating to for-profit entities. If you’re considering incorporating a not-for-profit, you’ll need to get some specific advice related to your situation.
What is the Difference?
A corporation is a separate legal entity. It is owned by shareholders, directed by the director, and run by the business’s officers, managers and employees.
Corporations provide a limited ability to shield individuals from liability. In Canada, this is not nearly as comprehensive as in other jurisdictions. If you conduct illegal business, it is still a crime. If you are negligent, the corporate veil does not protect you, depending on the circumstances. These are important legal matters that require a lawyer’s advice.
Why Would I Incorporate?
The first step to limiting your liability for running a business is insurance. Make sure you are appropriately insured. Appropriate insurance can often be better at protecting you and your personal assets than being incorporated.
However, if you have significant personal assets, incorporating can help shield those assets. For instance, a self-employed individual is a person. If the business gets sued, the person gets sued. The claimant can go after the person’s assets. There is no separation between the individual’s business and personal assets. If the business is incorporated and gets sued, the assets in jeopardy are usually limited to the assets owned by the corporation. Again, a lawyer’s advice should be sought on these matters, but sometimes being incorporated does not protect the individual completely.
The directors of a corporation direct the officers of the corporation in broad terms. The Officers direct the management and employees. The directors can be held liable if the business is grossly negligent or does not fulfill its financial obligations to its employees and the government.
Most businesses have two major trust accounts: payroll liabilities and GST/HST. These are funds the business collects in trust for another entity. For GST/HST, you are collecting on behalf of the Crown and must remit these to the Receiver General (think CRA). The money belongs to the king. For payroll liabilities, you are deducting them from your employees and paying on their behalf to the Receiver General. The money belongs to the employees. In both instances, the money does not belong to the corporation; it is held until it is paid to the Receiver General.
If you are considering a position as director of a corporation – for-profit or not-for-profit – be sure you understand that you are assuming liability. You should sign a director’s consent as part of accepting the position.
Tax Savings or Deferral Opportunities
The Canadian tax system is generally based on the idea of equalization. That is, no matter the structure, the same amount of taxes should be paid. In practice, this is not entirely true.
For instance, some opportunities are only available to corporations. This could be opportunities to engage customers, apply for grants, and get government funding. This list is by no means exhaustive.
A corporation creates some tax deferral and tax opportunities – but make sure it’s worth the cost before you incorporate. For instance, self-employed individuals must report their income on their T1 personal tax return. So if they made a lot of money, they pay a lot of tax. When an individual faces a big tax bill, they will often consider incorporating.
On the other hand, a corporation can pay a salary to the owner/manager of the corporation. That salary becomes a tax deduction for the corporation, and the owner/manager will pay tax based on their salary from their T4. This allows the owner/manager to limit the amount they get paid yearly to defer taxes to future periods. They can grow the business and build a saleable asset by leaving money in the corporation. This may allow the owner to take advantage of the Lifetime Capital Gains Exemption when they sell the corporation.
Transfer of Ownership
A corporation also allows for more succession planning opportunities and advanced tax planning (which we won’t explore in this article). The corporation’s ownership can be transferred to other individuals or corporations, new investors can be brought on board, and more. Further, the corporation can outlast you as an individual.
Many corporations out there plan on 5-year time horizons. But some of the biggest and most successful often have hundred-year plans. If you want to impact the world that survives you, you’ll need to consider incorporating at some point.
Understand your Responsibilities
When an individual incorporates without advice, they often find themselves scrambling to ensure they comply with the laws of the land. They can struggle with administrative tasks, learning the rules they need to follow, and paying the bills.
Compliance with the Law
It seems straightforward and obvious. However, a corporation has different requirements than an individual. For instance, bookkeeping MUST be done using the accrual method, not the cash method. If you don’t know what this means and you’re considering incorporating, it’s time for some advice.
We’ve written a few articles about the Corporate Record Book (click the title to go to our most recent.) This is one area that many owners neglect. Failure to keep the corporate record book current can result in serious fines and even jail.
Corporate Income Tax
Corporate income taxation rules are different from those for an individual. Getting good advice about your corporate taxes is important to ensure things are being done properly. The corporation may be of a specific type, such as a personal service corporation with limited deduction opportunities and a higher tax rate. The corporation may have limited activities that result in higher than anticipated taxes.
For instance, the Small Business Deduction is one of the key incentives for small businesses, but many corporations don’t qualify for it.
For instance, investment income earned within a corporation can result in significantly higher taxes than if the individual held those same investments.
Also, it’s important to remember that corporate taxes (T2s) are significantly more expensive than personal tax returns, so they must be budgeted appropriately.
Get advice if you’re considering transitioning from being self-employed to becoming an incorporated business. Failure to do so can result in unexpected headaches and unpleasant surprises. Make sure you do it right and for the right reasons.