Some weeks appear to have a recurring theme. The last couple of weeks I’ve been approached by a number of owners of sole proprietorship businesses wondering if it is time to incorporate their business. So what are the advantages and limitations of running a business as a sole proprietorship versus incorporating your business? So should you incorporate or sole proprietorship? Hopefully this will help with your decision.
If you taking more money out of your business than you require then this may be a tell-tale sign to investigate incorporating. As a sole proprietor, you have to declare all your income in that calendar year. The challenge with taking all your money out is you’re paying a higher marginal tax rate on your personal income tax (as much as 53.5%) versus leaving it in your business and paying a small business corporate tax rate of 13.5%.
Managing Cash Flow
As an incorporated business, leaving money in the corporation allows you to better plan for a rainy day. It’s not uncommon for a business to have a cashflow drought on occasion. Your expenses, payroll obligations don’t go away so building up a cash nest egg will help to ease the challenges through these periods.
Limiting Your Liability
Although incorporating your business doesn’t safeguard your assets, it does make it more difficult for creditors to go after your personal assets (house, investments etc). There are some other measures that you can do to further safeguard and protect your assets more effectively.
Some clients and suppliers that you may deal with may give them a higher level of stability when dealing with you. It may only be perception but incorporating gives some companies a greater comfort level in dealing with you and indication of greater longevity.
Personal Pension Plan
By incorporating your business, you have the ability to set up a Personal Pension Plan (PPP) that is completely funded by your business. This is a huge benefit for incorporated business and professionals as it gives you significantly greater contribution room versus your RRSP, has huge tax advantages for the corporation and is completely creditor protected.
Other Wealth Building Strategies
There are a number of other wealth building strategies that corporations can take advantage of over a sole proprietorship. Things like Corporate Insured Retirement Plans (CIRP), Split Dollar Critical Illness, Retirement Compensation Arrangements (RCA) allow for tax efficient means of getting money out of your business. You can set up similar type strategies as a Sole Proprietor but you’d be paying for it in after personal tax income which can limit your growth potential significantly.
If one day you’re likely to want to sell your business, you will need to sell shares of your business to take advantage of your Lifetime Capital Gains Exemption (LCGE). Whether this is to an internal employee or a third party company, selling shares of an incorporated business is the only way to take advantage of the LCGE.
Disadvantages of Incorporating Your Business
Incorporating is not for everyone. It can be an added cost to your business that isn’t necessarily something you need to add this expense. Here are some of the reasons why incorporating may not make sense for your business.
Taking All Your Revenue Every Year
If you’re need to take all your money out of your business every year then there may not be an advantage for you to incorporate. Although there may be other reasons to incorporate, you may not get any financial advantage out of it.
There are definitely added costs to incorporating. Registering your corporation will require accountants and lawyers to set it up. Also, filing your annual corporate tax return is an added expense every year. If you set up an Operating Company and a Holding Company then you will have an added corporate return every year as well. To see why you may want to set up a Holdco in addition to an Operating Company please read one of my previous posts.
With filing a corporate tax return, it entails greater detail to submit. Whether you have a financial person or bookkeeper that you retain, it will take greater time to prepare for your annual tax submission.
No Personal Tax Credits
If you are incorporated, you likely are submitting business expenses through your corporation versus on your personal income tax return. A sole proprietor is able to write off these expenses on his/her personal income tax return.
Closing Up a Corporation Can Be Difficult
If you decide to wind up a corporation, it’s not as straightforward as simply making a call or writing a letter. It likely will entail letters from your accountant/lawyer to start the proceedings. You are also obligated to submit a corporate tax return up to including your last day of operations.
There are a number of significant advantages to incorporating but it’s not for everyone. If you’re growing a business, are exposed to potential risk within your business (potential for being sued), have good profitability beyond your means and are looking at tax efficient ways of getting money out of your business then you may want to talk to an accounting professional to see if it make sense for you.
incorporate or sole proprietorship