Should I incorporate?
For most full time businesses, the question is not if, but when, to incorporate. But what if you’re just running a side gig? Is it still worth incorporating?
Everyone’s situations differ so the key is to understand what incorporation is all about. From there, you can make your own decision about whether incorporating is right for you.
We’re going to take a look at the pros and cons of incorporation to help you decide if, when, and how you should incorporate.
The Pros of Incorporating a Business
Limiting Liability. Running your business through a corporation provides a layer or protection against personal liability. If a product or service sold through the company is defective, then the company is one the hook or the liability – not you personally. The protection also applies to creditors. If your company owes them money they can’t come after you personally. There are situations where you still have personal liability, but a corporation makes it much more difficult for someone to go after your personal assets if your business fails.
Tax Efficiency. Corporate tax rates in Canada are generally lower than personal income tax rates. If you’re running a small business that falls in the category of a Canadian Controlled Private Corporation (CCPC), then you may even qualify for the small business tax deduction. This means that your federal tax rates would only be 9%!
Even if you’re not a CCPC, a corporation is much more tax efficient than individuals. Just one example of this would be deferring income for yourself. Imagine your corporation makes 200K this year, but you’ve already made 100K at another job.
If you paid yourself the 200K, then the taxes you would pay on it are incredibly high. However, since you have a corporation you can hold the money in the corporate bank account, and pay yourself later (maybe even when you’re retired) to take advantage of a lower income bracket.
Taxes are one of those things where paying a professional to do it will actually save you money in the long run. We highly recommend getting an accountant to look over your personal and corporate tax situation.
Income Splitting. Prior to 2018, income splitting was one of the main reasons people incorporated their small or side businesses. Dividends could be used to move money to a lower-income spouse who is taxed at a lower rate.
As of January 1, 2018, the CRA significantly defanged this tool. The rules are now designed to limit the benefit of income splitting through private corporations, and impose additional criteria on when income splitting is allowed.
There is a lot of grey area on what is and is not allowed. The interpretation of CRA rules can make a big difference on how much income splitting you can do.
If income splitting is the only reason you’re considering incorporation, then we would suggest that this is not the right time for you to incorporate. Income splitting should be considered an added bonus if it works out.
Estate Planning. Corporations endure even when you pass away. Using a corporation to hold assets can be a good way to transfer ownership over to your heirs when you are gone. If you’re planning on doing this, then make sure you consult with a lawyer so that a written plan is in place for exactly what needs to happen when you pass away.
The Cons of Incorporating a Business
Costs. Unfortunately there are costs involved with incorporation. You’ll need a lawyer for the paperwork, and likely an accountant to do your taxes. For a provincially incorporated small business, the cost of the initial incorporation is usually around $1,000 to $2,000. The ongoing costs of maintaining your corporation and having an accountant take care of the provincial and federal taxes is around $1,500-$3,000 a year.
You can incorporate yourself for far less money, but you run the risk of having to amend your articles of incorporation or shareholder agreement at a later date if you mess it up at the beginning.
We recommend using a lawyer for the incorporation, and having an accountant do your taxes for at least the first year. After the first year, you can take a look at the tax paperwork to see if you would be comfortable doing it by yourself.
Administrative Work. It takes quite a bit of work to keep records on all of your business activities. Things like contracts, producing financial statements, and depreciating inventory can become more burdensome once you’re a corporation. If you’re already financially savvy, then this likely won’t cause you too much stress. However, if you hate keeping track of detailed numbers then this work can be very draining.
Business Losses. If you’re running your business as a sole-proprietor, then you can deduct your business losses against your other sources of income. However, if your corporation incurs a loss, then that loss stays with the corporation. You are unable to deduct that corporate loss against other sources of persona income you have.
Things to Consider When Incorporating
Can I incorporate myself? You can if you want. You can do this online or just print out the standard paperwork. However, there are enough complexities with setting up a corporation that we don’t recommend you do this unless you’re very comfortable with legal documents. Shareholder agreements, articles of incorporation, and specific rules around certain industries can all cause issues.
Should I incorporate Provincially or Federally? Provincial incorporation is good enough for most businesses. Incorporating in a single province doesn’t mean that you can’t do business with entities outside of your home province. However, there are certain restrictions such as not being allowed to hold inventory or having an office outside of the province you’re incorporated in.