What Are the Pros and Cons of Incorporating Your BusinessBrian Jang ON November 8, 2018
If you are a small business owner, you may be wresting with whether or not to incorporate your business. While incorporating does offer advantages, it is not without disadvantages. If you are having trouble deciding, it’s worth examining both sides.
What are the Advantages of Incorporating?
- Limited Liability
One key advantage of incorporating is that the incorporated company has limited liability. In an incorporated business, an individual shareholder’s liability is determined by the amount they have invested in the company.
If, on the other hand, you are a sole proprietor, your personal assets may be seized to pay the debts of your business; your car and even your home are fair game. Unless you give a personal guarantee, then you cannot be held responsible as a shareholder.
Note that corporations have the same rights as individuals, meaning that they can own property, incur liabilities, sue, and be sued.
- Easier Fundraising
Corporations may find it easier to develop and expand due to their greater ability to raise money. They can do so through borrowing, just as any company can, but they also have the ability to raise money through equity financing, which involves the selling of shares to venture capitalists and angel investors.
Equity financing has the advantage that equity capital generally does not need to be repaid and does not incur interest. The downside to this, however, is that you are reducing your percentage of ownership.
- Name Protection
Once incorporated, your business name is reserved for your use in the province where you incorporate. If you incorporate federally, you have the right to use your business name throughout the country. Partnerships and sole proprietorships have no name protection, meaning that anyone is free to start their own business with the same name if they desire.
- Corporate Continuance
A corporation has an unlimited lifespan; even if all of the shareholders die, move on from the business, or if the business changes hands to a new owner, it will continue to exist, unlike a sole proprietorship. It is also easier to sell a corporation.
- Optimization of Income and Taxes
By incorporating your small business, you gain a significant advantage by being able to determine when you will receive income from the business. This means that instead of taking salary immediately upon the business receiving income, you can wait until such time that you will pay less tax. You may also choose to receive income in the form of dividends, which will reduce your tax bill.
- Potential Tax Deferral
If you are a higher income earner, being incorporated gives you tax deferral potential. Given that business tax rates are much lower than personal tax rates, you may choose to leave money in the business in order to withdraw it at a more favourable time.
- Income Splitting
This tax advantage refers to the fact that shareholders need not be actively involved in the business in order to receive dividends. Consequently, your spouse and children can be shareholders in the corporation, allowing you to spread income from family members in higher tax brackets to those with lower income, who are taxed at a lower rate.
- Small Business Tax Deduction
Incorporating your business may qualify you for the federal small business deduction. This deduction, available only in Canada, is calculated at 10.5% on the first $500,000 of taxable income, which may bring your corporate business tax down to a much lower tax rate that your personal income.
What Are the Disadvantages of Incorporating?
So far, the idea of incorporating sounds rather appealing, but there are some disadvantages that are worth considering.
- More Paperwork
Maintaining a corporation involves a great deal more paperwork than a partnership or sole proprietorship. This includes keeping corporate documents such as the share register, transfer register, and register of directors up to date. Corporations must also maintain a minute book with the corporate bylaws and minutes from corporate meetings.
Further, you will have to file two tax returns each year—personal and corporate. This will result in greater accounting fees.
- Less Tax Flexibility
Corporations have less flexibility when it comes to handling business losses than a sole proprietorship or even a partnership. Sole proprietors have the option to use business losses to reduce other types of personal income, while corporations can merely carry them forward or back to reduce the corporation’s income from other years.
Being incorporated may also prove to be a liability in that sole proprietors may be able to claim tax credits that corporations are unable to.
- Limited Liability, Yes, But…
Limited liability is one of the greatest advantages of incorporating, however it can be undercut by credit agreements or personal guarantees.
Further, if the corporation is viewed by lending institutions as having insufficient assets, they may not be able to secure debt financing, and may be required to offer personal guarantees. This results in the owner being personally liable if the corporation is unable to make repayments.
- It’s More Expensive
Setting up a corporation is more expensive when it is incorporated, owing to a more complex legal structure.
- They Are More Difficult to Dissolve
In order to close a corporation, a resolution must be passed agreeing to dissolve, payroll accounts must be closed, and a copy of the Certificate of Dissolution must be sent to the CRA. A final tax return must also be filed.
As you can see, there are pros and cons to incorporating. It is worth discussing with your accountant or lawyer before making a final decision. They will be able to give you a more complete idea of how incorporating will impact your business.
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