Advantages of incorporation
Lower tax rate
We all know that paying taxes is important but let’s be honest: most of us would prefer to owe less, right? Well, this is one of the advantages of incorporation. Corporate tax rates are generally lower than personal income tax rates, resulting in significant savings at tax time.
Incorporated businesses may also qualify for the federal small business deduction (SBD), which can significantly lower your tax rate and reduce the amount of tax owed. For example, according to the tax rates in effect as of January 1, 2021, a corporation that qualified for the Small Business Deduction would pay income tax at the rate of 3.2% in Ontario, while corporations of other types in the same province would pay tax at a rate of 11.5%.
If you are a higher income earner, you can also take advantage of tax deferral when you incorporate, which can help reduce how much tax you owe. When you’re a sole proprietor or in a partnership, the government sees your business income and personal income as one, and you will be taxed on everything you earned in a year at the personal tax rate.
However, when you incorporate, your business income and your personal income are taxed separately, so you can leave money in your business and take it out later when your personal tax rate is lower.
One of the biggest advantages of incorporation is limited liability.
“When you incorporate, you are creating a separate person in the eyes of the law, so all of your debts and liabilities, for the most part, are kept to the company, which means it helps you protect your personal assets,” explains Jaime Bell, lawyer and founder of Contracts Market and Wild Coast Law.
In other words, if your corporation suffers significant losses, gets sued, or goes bankrupt, you likely won’t be at risk of losing your personal assets to cover those costs. Company owners (i.e. shareholders) are not responsible for a corporation’s debts and they will only lose what they’ve invested.
In comparison, if you’re a sole proprietor, the government or lenders could seize your personal assets (e.g., your home, car, property, etc.) to pay your business’ debts or damages. However, it’s important to note that if you did something fraudulent, you could still be held liable for damages, despite being incorporated.
Access to financing
Starting a business can be very expensive. Fortunately, corporations can raise money by selling shares or bonds to investors. Grant programs are another great way to finance a business, and many are only available to incorporated companies. Lastly, corporations can often get a business loan at lower rates than sole proprietorships or partnerships.
Business name protection
Finding the perfect name for your business can be a long, difficult process. Now, imagine if someone started a company with the same name. Unfortunately, that scenario can happen if you’re not incorporated.
Provincially incorporating your business will protect your business name in that province. Alternatively, federally incorporating your business will give you the right to use your business name across the country.
While you don’t need to incorporate your business to be successful, some potential clients or customers may perceive an incorporated company as more legitimate and trustworthy, which could help you attract new business. Some clients or government agencies may even require incorporation before they’ll work with you.
With other business structures, a business ceases to exist once the owner dies. However, an incorporated company will live on until they wind down, amalgamate, or give up its charter (e.g., go bankrupt). If selling your business in the future or transferring ownership to a successor is a possibility, incorporating your business can help make this process easier.
Disadvantages of incorporation
Costs of incorporation
Setting up a corporation is more complicated than a sole proprietorship or partnership, so naturally, it also costs more. Although you can use the government’s self-service website for as little as $200 (or a service like Ownr which starts at $499), using a lawyer is recommended to make sure that your corporation is set up correctly. A simple incorporation typically costs about $1,000, but the process can cost upwards of $3,500.
Increased accounting costs
Since your business is now a separate legal entity, you will need to file two tax returns: one for your personal income and one for your business. Depending on how complex your finances are, hiring an accountant to file your self-employed tax return can range from $150-$350. In comparison, a corporate tax filing can cost up to $2,500. In addition, corporations are also not eligible for personal tax credits, which could also potentially affect how much tax you owe overall.
Increased administrative work
There is a lot of administrative work required to maintain a corporation. For example, your corporation must keep up-to-date records that include a minute book, share register, securities register, articles of amendment, and more. You will also need to prepare financial statements, appoint an auditor to audit the corporation’s financial statements, and file an annual return, among other tasks.
All of this paperwork is required to keep your corporation in good standing. Failure to do so may lead you to incur fees and penalties, lose your personal liability protection, or even have your business dissolved.
Incorporating your business doesn’t completely protect you from liability. For example, if your corporation doesn’t have sufficient assets to secure debt financing, lending institutions will often insist on having the business owner guarantee the loan. This means that you and your personal assets would still be on the hook if your business can’t meet its repayment obligations, essentially making your corporation’s “limited liability” null and void.
The bottom line: Should I incorporate my business?
Bell suggests assessing the overall risk level of your business. For example, fitness, tourism, food and beverage and children-focused companies would be considered high-risk. If you work in these industries, says Bell, the limited liability protection that comes with incorporation could help give you and your clientele more peace of mind.
“That’s a conversation you probably want to start having with a lawyer, especially around those industries,” says Bell. “‘Is it worth it for me to incorporate for that protection? Or is insurance enough?’”
Another factor to consider is how much money you earn and how much you can leave in the corporation. As mentioned above, tax deferral can be a benefit of incorporation for high-earning business owners who want to lower their tax bills. However, if you’re not able to leave a significant portion of your income in your corporation, then you wouldn’t be able to benefit much from tax deferral.
Ultimately, Bell recommends business owners do a cost-benefit analysis and consult with an accountant and lawyer to understand if incorporation is the right move for their business.
For example, suppose you’re running a high-revenue business in a risky industry with a lot of personal assets you need to protect. In that case, the additional costs and paperwork that come with incorporation may be worth it. And if the opposite is true, you might want to register your business as a sole proprietorship or partnership to start and incorporate your business when the pros outweigh the cons.