Should I Incorporate My Business?

Should I incorporate my business? This is a question that is often asked by many of our clients. As a business owner, at some point in your business life cycle, you will have questions about whether you have the right structure in place to support your business and its expansion.

Most small businesses start out as a sole proprietorship but as they grow, this arrangement can become less beneficial. The right structure can help you save on taxes and allow you to do planning that is otherwise not available as a sole proprietorship. Generally speaking, incorporating your business provides greater advantages than operating as a sole proprietorship to both owners and the business itself. Nonetheless, incorporation brings with it a range of benefits and drawbacks that should be carefully considered before making a decision. In this article, we will explore the benefits and disadvantages of incorporating your business, providing you with the information you need to make an informed choice.

What does it mean to incorporate?

Before one decides to incorporate their business, it is important to understand what “incorporating” means. Essentially it is the process of establishing a new legal entity that is separate from you as an individual owner. Legally, corporations possess the same rights and responsibilities as individuals. This means that they can enter contracts, carry on business, own assets, incur liabilities, hire employees, and pay taxes by incorporating your business, you create a separate legal structure that can protect your personal assets and limit your personal liability.

Now, let's delve into the pros and cons of incorporating your business in more detail.

What are the benefits of incorporating?

1. Limited liability

This is probably the greatest advantage of incorporating. Limited liability means that the owner doesn’t assume personal responsibility for the obligations of the corporation compared to a sole proprietorship. Thus, when you are operating your business through a corporation, it makes it more difficult for someone to go after your personal assets if the business defaults on its debts. Hence, even if a corporation goes bankrupt, shareholders losses are limited to the amount invested in the corporation. Thus, Limited liability protection can provide peace of mind and safeguard your personal wealth.

2. Easier access to capital

Similar to an individual, corporation can obtain financing from financial institutions. Some lenders view corporations as more stable and credible than unincorporated businesses and for this reason, it is easier for them to get financing. A corporation also has the ability to raise capital through issuing shares or bonds to investors.

3. Continuous existence

Another key advantage of a corporation is that it continues its existence regardless of what happens to the shareholder. This can be particularly beneficial for businesses with long-term goals and succession planning. In the event of a shareholder's death or departure, ownership can easily transfer to the remaining shareholders or their heirs without disrupting the operations of the business. In contrast, under a sole proprietorship, the business dissolves or stops existing when the proprietor passes away. In comparison, as the corporation is a separate legal entity, it has an infinite lifespan. Essentially a corporation continues its existence until it has been dissolved.

4. Lower tax rates and tax deferral

Another advantage of incorporation is the potential for tax benefits. Corporations often have more favorable tax treatment compared to other business structures. For example, corporate profits are taxed at lower tax rates than personal tax rates. This can result in potential tax savings, especially if your business generates significant profits and allow you to retain more earnings within the business and potentially reinvest them for growth. Essentially, operating your business through a corporation gives access to various tax planning opportunities and tax savings, including:

• income splitting between shareholders (new rules under the Income Tax Act have reduced the effectiveness of this strategy for private corporations);
• utilizing the federal small business deduction that gives rise to reduced corporate tax rates;
• deferring tax until funds are withdrawn from the corporation; and
• utilizing the lifetime capital gains exemption on the sale of shares of the corporation.

Related: Tax Advantages of a Canadian Controlled Private Corporation (CCPC)

What are the disadvantages of incorporating?

While there are numerous advantages to incorporating your business, it's important to consider the potential drawbacks as well. Here are some disadvantages to keep in mind:

1. Lenders may require personal guarantee

If your corporation has few assets, a lender of business loans may require shareholders to provide personal guarantees. As part of the personal guarantee agreement, a lender can take possession of the shareholder's personal assets, thereby defeating the protection of liability under a corporation.

2. Limited ability to claim losses

If your incorporated business operates at a loss and is eventually shut down, you may not be able to personally claim these losses on your income tax return. The amount you can claim is limited to the money you invested or lent to the business. In contrast, sole proprietorships often allow business losses to be offset against other personal income, potentially resulting in greater tax savings.

3. Additional filings required

Corporations are subject to more extensive reporting and compliance requirements compared to sole proprietorships. This includes filing separate annual tax returns, annual reports, and notifying authorities about changes in directors or share sales. The increased paperwork and administrative obligations can be time-consuming and require a thorough understanding of corporate regulations.

4. More expensive to set up

Incorporating a business incurs additional costs compared to operating as a sole proprietorship. These costs include legal fees for the incorporation process, annual fees to maintain the corporation's good standing, and potentially hiring professionals like accountants to handle corporate tax filings. The financial burden of these ongoing costs may be prohibitive for younger or smaller businesses.

5. Loss of personal control

When you incorporate your business, you may experience a loss of personal control over decision-making. As a corporation, decisions are made collectively by the board of directors and shareholders. This means that you may have to consult and obtain approval from others before implementing certain strategies or making major business decisions. If you value autonomy and the ability to make independent choices, incorporating your business may limit your personal control.

When should I incorporate my business?

Deciding whether to incorporate your business requires a thorough cost-benefit analysis. Consider the advantages and disadvantages discussed earlier and evaluate how they align with your business goals and long-term vision.

If protecting your personal assets and limiting personal liability are paramount, incorporation can offer significant benefits. The limited liability protection alone may outweigh the increased paperwork and legal obligations. Additionally, if you anticipate significant profits or the need to raise capital in the future, incorporating your business can provide tax advantages and access to additional funding sources.

However, if you value simplicity, personal control, and lower initial costs, incorporating your business may not be the best fit. Other business structures, such as sole proprietorships or partnerships, may offer a more straightforward and cost-effective approach.

Ultimately, the decision to incorporate your business should be based on a careful evaluation of your unique circumstances, future business plans, and tolerance for administrative requirements. It may be helpful to consult with legal and financial professionals who can provide guidance tailored to your specific needs.

Steps to incorporate your business

If you decide that incorporation is the right move for your business, here are the general steps involved in the incorporation process:

1. Choose a business name: Select a unique name for your corporation that complies with legal requirements and reflects your brand identity.
2. File articles of incorporation: Prepare and file articles of incorporation with the appropriate government agency. This document outlines essential details such as the corporation's name, purpose, and stock structure.
3. Draft corporate bylaws: Develop corporate bylaws that establish the rules and procedures for governing the corporation. Bylaws typically cover topics such as shareholder meetings, board of directors' responsibilities, and decision-making processes.
4. Appoint directors and officers: Select individuals to serve as directors and officers of the corporation. Directors are responsible for overseeing the company's affairs, while officers handle day-to-day operations.
5. Obtain necessary licenses and permits: Depending on your industry and location, you may need to obtain specific licenses and permits to operate your corporation legally. Research and comply with all relevant regulations.
6. Issue stock certificates: If you plan to raise capital by selling shares, you will need to issue stock certificates to shareholders. Establish a stock ledger to track ownership and transfers of stock.
7. Hold an initial board of directors meeting: Conduct an initial board of directors meeting to adopt the bylaws, appoint officers, and address any other necessary matters.
8. File required reports and maintain records: After incorporation, you will need to fulfill ongoing requirements, such as filing annual reports, maintaining corporate records, and adhering to other legal obligations specific to your jurisdiction.

It is important to note that the incorporation process can vary depending on the province in which you operate. To learn about the step-by-step process on how to incorporate a company in Ontario, read our blog article. Further, consulting with legal professionals or tax accountants can help ensure compliance with the specific requirements in your jurisdiction.

Conclusion

“Should I incorporate my business” is a question that should only be answered after taking the advantages and disadvantages specific to your situation. By weighing the potential benefits of limited liability, tax advantages, access to capital, and continuity against the costs and administrative burdens, you can make an informed choice about whether incorporation is the right move for your business. Consulting with professionals such as accountants and lawyers can provide guidance tailored to your circumstances and ensure compliance with legal requirements. Remember, each business is unique, and what works for one may not necessarily be the best choice for another. If you’re still unsure and are looking for an accountant in Hamilton to provide professional guidance, contact us.

If you want to learn more about other tax and accounting topics, explore the rest of our blog!

Disclaimer

The information provided on this page is intended to provide general information. The information does not take into account your personal situation and is not intended to be used without consultation from accounting/tax professionals. NBG Chartered Professional Accountant Professional Corporation will not be held liable for any problems that arise from the usage of the information provided on this page.