Many small-business owners in B.C. consider incorporating as their businesses grow.
While corporations pay higher fees and face more involved reporting requirements than sole proprietorships do, there are benefits to consider. Learning about the following six advantages may help you decide if incorporating is right for you.
1. Incorporating provides liability protection
Nick Papoutsis, community manager at BlueShore Financial, Whistler, says a big advantage to incorporating is protection for your personal assets.
“As a sole proprietor you’re responsible for the liabilities of your business, and your personal assets can be seized to pay company debt. If you incorporate, your personal assets are likely protected from any potential legal challenges your company may face, so your risk of personal loss is limited to the amount you’ve invested into your company.”
2. Corporate and personal taxes are separated
A second advantage arises because corporations pay different tax rates than individuals do. Incorporating separates the tax you pay on your personal and business income.
“Your tax advisor can explore what your effective corporate tax rate would be if incorporated and compare it to your personal effective tax rate,” comments Papoutsis. “If it is lower, incorporating may be beneficial.”
3. Income splitting opportunities
Potential “income splitting” opportunities can exist within a corporate structure. Companies are able to pay dividends to their shareholders from earnings, and a shareholder doesn’t have to be active in the business to receive them.
Your spouse and/or your children can therefore become shareholders, giving you the opportunity to redistribute income to family members who are in a lower tax bracket.
4. The small-business deduction may apply
While the rules are complicated and we recommend you seek professional advice for your particular circumstance, if your company is a Canadian-controlled private corporation (CCPC) it may qualify for a federal business deduction on active business income earned in Canada. This small-business deduction is currently based on the first $500,000 of taxable income, and may reduce your net business tax to a lower rate than is applied to your personal income.
5. Your shares may qualify for a capital gains tax deduction when sold
If your shares are deemed to be qualified-small-business-corporation shares and they meet certain other requirements, you may also be eligible for an $800,000 lifetime capital gains tax exemption when you sell them ($800,000 for 2014, indexed after 2015). This can significantly reduce the amount of tax you pay when you leave your business.
As with the small-business deduction, seeking professional advice to determine if your shares would qualify for the exemption is essential before incorporating.
6. Incorporating can help with succession planning
Lastly, a corporation enjoys perpetual or continuous existence.
Papoutsis notes, “In the event of death, the net assets of a sole proprietorship pass to the heirs, but contracts and leases critical to the business may not. A corporation, on the other hand, and all the contracts and agreements it has established, should, if planned properly, continue to exist if an owner dies or ownership changes.”
Being able to transfer corporate shares therefore offers an advantage when it comes time for succession. You may plan for an outright sale, a gift or a family purchase. Regardless of the option chosen, the corporation and all its contracts and leases should remain in place, and only ownership of the shares should be impacted.
While incorporation has its advantages, particularly in lowering taxes, it’s important to consult your advisory team before proceeding.