Should You Incorporate Your Small Business?
Every small business person considers whether or not to incorporate his business at some point. The form of a business isn't immutable; you can change the legal structure of your business as it grows. A common scenario is for small businesses to start out as sole proprietorships or partnerships and become incorporated at some later date when the business has grown
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If you're one of the people considering incorporating your business, here are the main advantages of incorporating: 1. Limited Liability The main advantage to incorporating is the limited liability of the incorporated company. Unlike the sole proprietorship, where the business owner assumes all the liability of the company, when a business becomes incorporated, an individual shareholder's liability is limited to the amount he or she has invested in the company. |
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If you're a sole proprietor, your personal assets, such as your house and car can be seized to pay the debts of your business; as a shareholder in a corporation, you can't be held responsible for the debts of the corporation unless you've given a personal guarantee.
On the other hand, a corporation has the same rights as an individual; a corporation can own property, carry on business, incur liabilities and sue or be sued.
2. Corporations Carry On
Another advantage of incorporating is continuance. Unlike a sole proprietorship, a corporation has an unlimited life span; the corporation will continue to exist even if the shareholders die or leave the business, or if the ownership of the business changes.
3. Raising Money Is Easier
Corporations also have more ability to raise money, which may make it easier for your business to grow and develop. While corporations can borrow and incur debt like any sole proprietorship, they can also sell shares and raise equity capital, a big advantage because equity capital generally does not have to be repaid and incurs no interest. (Of course, by issuing shares, you are reducing your percentage of ownership in the company.)
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4. Income Control If you incorporate your small business, you can determine when you personally receive income, a real tax advantage. Instead of getting your income when it's received, being incorporated allows you to take your income at a time when you'll pay less in tax. 5. Potential Tax Deferral Becoming incorporated gives you tax deferral potential. |
Because you can defer paying some tax until a later time, you may be able to realize tax savings if you are then in a lower tax bracket, or if the tax rates have fallen.
6. Income Splitting
Another tax advantage of incorporating is income splitting. Corporations pay dividends to their shareholders from the company's earnings. A shareholder does not have to be actively involved in the corporation's business activities to receive dividends. Your spouse and/or your children could be shareholders in your corporation, giving you the opportunity to redistribute income from family members in higher tax brackets to family members with lower incomes that are taxed at a lower rate.7. The Small Business Tax Deduction
If you incorporate your small business, your corporation may qualify for the small business deduction. This annual tax credit is calculated at the rate of 16% on the first $200,000 of taxable income, which may be a much lower tax rate than that applied to your personal income.
8. Increased Business?
Having Ltd., Inc., Ltee., or Corp. as part of your company's name may increase your business, as people perceive corporations as being more stable than unincorporated businesses. If you're a contractor, you may also find that some companies will only do business with incorporated companies, because of liability issues.
Incorporating your small business sounds like a great idea, doesn't it? But there are also disadvantages to incorporating that you need to consider.
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While there are several advantages to incorporating a small business, there are also disadvantages that need to be considered. The main disadvantages of incorporating, I think, are the increases in paperwork and cost, which can be substantial compared to a sole proprietorship or partnership. 1. Another Tax Return When you incorporate your small business, you'll have to file two tax returns each year, one for your personal income, and one for the corporation. This, of course, will mean increased |
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accounting fees. Unlike a sole proprietorship or partnership, corporate losses can't be deducted from the personal income of the owner.
2. Increased Paperwork
There is a lot more paperwork involved in maintaining a corporation than a sole proprietorship or partnership. Corporations, for example, must maintain a minute book, containing the corporate bylaws and minutes from corporate meetings. Other corporate documents, that must be kept up to date at all times, include the register of directors, the share register, and the transfer register. (See Getting Your New Corporation Up and Running for more information on the corporate minute book and other documents necessary for corporations.)
3. No Personal Tax Credits
Another disadvantage of incorporating is that being incorporated may actually be a tax disadvantage for your business. Corporations are not eligible for personal tax credits. Every dollar a corporation earned is taxed. As a sole proprietor, you may be able to claim tax credits a corporation could not.
4. Less Tax Flexibility
A corporation doesn't have the same flexibility in handling business losses as a sole proprietorship or a partnership. As a sole proprietor, if your business experiences operating losses, you could use these to reduce other types of personal income in the year the losses occur. See "8 Tax strategies to Maximize Your Business Tax Deductions". In a corporation, however, these losses can only be carried forward or back to reduce the corporation's income from other years.
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5. Liability May Not Be As Limited As You Think The prime advantage of incorporating, limited liability, may be undercut by personal guarantees and/or credit agreements. The corporation's much vaunted limited liability is irrelevant if no one will give the corporation credit. When a corporation has what lending institutions consider to be insufficient assets to secure a loan, they often insist on personal guarantees from the business owner(s). So although technically the corporation has limited liability, the owner still ends up being personally liable if the corporation can't meet its repayment obligations. |
6. Registering A Corporation is Expensive
A further disadvantage of incorporating is that corporations are more expensive to set up. A corporation is a more complex legal structure than a sole proprietorship or partnership, so it's logical that creating one would be more complicated and costly. Fees for incorporating a small business either provincially or federally range in the hundreds of dollars - and that's just for the set up. I've already mentioned the increased maintenance and related fees, such as increased accounting costs.
Should you incorporate your small business? I've outlined the advantages and disadvantages of incorporating in this article, and you can find more information about how to incorporate your business in my Incorporating A Business library of links, but I strongly recommend that you discuss your personal situation with your accountant and lawyer before you decide. He or she will be able to give you a much more exact picture of how incorporation could benefit your business, and help you see whether or not the trouble and expense of incorporation will be worth it to you.