The Decision to Incorporate [Part 3]

Advantages of Incorporation

While there are many benefits to incorporating there are also some costs.  Let’s consider these first.

Cost of Incorporating

1.  Inability to utilize losses – Many new businesses will have losses during the start- up years.  If these losses are incurred in an unincorporated business they can be offset against other sources of income on your personal tax return.  If these losses are incurred in a corporation they will not be able to be claimed until they can be offset against future profitable years.

2. Professional fees –  Setting up a new corporation will cost about $1,500 in incorporation costs.  In addition, the accounting fees to prepare corporate tax returns will be more.

3. There is a  greater potential for business owners to run afoul of the Income Tax Act as they often fail to grasp the concept that the corporation is a separate person for tax purposes.  Shareholders can “borrow” company funds for personal use and only learn of the tax consequences much later.

Benefits of Incorporating

1. Creditor proofing your personal assets – Incorporating your business separates your business from your personal assets.  This makes it more difficult for creditors to be able to access your home, RRSP or other personal assets.

2. $750,000 capital gains exemption –   Many start-up businesses can end up being worth millions.  If you sell the business you will have a taxable capital gain on the sale of the business.    If you sell the shares of the business instead of the assets you, and each shareholder, may be entitled to a $750,000 capital gains exemption.

3.  Corporations can choose to have a non-calendar year end – something an unincorporated business cannot have. A corporation can select a year end when the business cycle slows down making it easier to do year end procedures such as taking inventory etc.

4.  Enhanced Income Splitting – Income splitting is the diversion of business income to family members who have relatively low incomes and are subject to low marginal tax rates.  In order to be able to claim a deduction for wages paid to a spouse or children they must be reasonable in relation to the services performed.  This restricts the ability to use salaries as an income splitting tool.  There is no such restriction for dividends.  Spouses and children [with due regard for the “kiddie tax”] can subscribe for shares in the corporation.  They can share equally in the dividend payments from their corporation and in so doing maximize the potential for income splitting.