When should I incorporate my business?

by margento | October 27, 2022

Deciding to incorporate your business is a big one. It can be an exciting time, but it’s essential to take the time to make sure you are ready and that you have all of the information you need.

There are many factors to consider, such as:

  • Financial resources
  • Financial goals
  • Tax situation
  • What type of industry do you operate in
  • Whether you are ready to take on the added responsibility

By researching and asking for professional input, you can make an informed decision that will be best for your business and future!

1. What is incorporation, and why do businesses choose to incorporate? 

2. The different types of business structures and the benefits of each 

3. What you need to do to incorporate your business 

4. The costs associated with incorporating a business 

5. How to get started with incorporating your business

6. The disadvantages of incorporation 

7. When is the right time to incorporate your business? 

8. What are the risks of incorporating

What is incorporation, and why do businesses choose to incorporate? 

Incorporating a business is the process of forming a legal entity separate from the owners of the company. This legal entity can then be treated as its own individual regarding taxation and other laws. There are many reasons businesses choose to incorporate, including:

1. Limited liability – One of the most significant benefits of incorporating your business is that owners are typically shielded from personal liability for the debts and liabilities of the corporation. For example, if you are a construction company and the corporation gets sued, the shareholders of your corporation won’t be risking their personal assets in a court case.  However, if you are a corporation and this happens, the assets exposed to the risk will only be those held by the corporation.  Depending on the nature of your industry, this could be a very important factor to consider when choosing to incorporate or not.

2. Tax benefits – Corporations are taxed separately from their owners, which can result in tax savings for the business since corporate tax is lower than personal tax.  For example, let’s say you earn $150,000 in income after expenses and spend $50,000 on personal living expenses.  As a sole proprietor, you will pay tax on the entire $150,000 of income you earned – you will end up with approximately $103,000 after-tax income.  Lets consider the same situation but for someone who was incorporated and paid themselves a dividend for $50,000 – you will end up with $130,000 after-tax income if you can leave $100,000 of the $150,000 profit inside your company.  This gives you a significant tax benefit which allows you to use that extra cash to reinvest in your corporation and grow your company.  However, if you are a big spender and spend $150,000 of your income on personal expenses (not advisable!), then there is no tax benefit to incorporate.

3. Lifetime capital gains exemption – If you decide to sell your shares in the company at a later date, your corporation may qualify for the lifetime capital gains exemption, and you will be able to receive up to $913,630 tax-free.  For example, let us say you had incorporated a construction business and grew this business to be worth $900,000.  Along comes someone who wants to buy your company.  Your business was built from nothing, so the value you paid for it is nothing.  If you qualify for the capital gains exemption, you could sell your business for $900,000 without triggering the tax.  If you didn’t have this exemption, you would be paying around $196,000 in personal tax.

4. The ability to raise capital – One of the most significant benefits of incorporation is raising capital by selling shares in your company. This can be a great way to get started if you don’t have the financial resources to start your own business.

5. Credibility and professionalism – By incorporating your business, you are showing potential customers and partners that you are serious about your venture and taking steps to protect yourself legally. This can help you build trust and credibility with those you work with.

The different types of business structures and the benefits of each

When starting your business, one of the first things you need to decide is what type of business structure to choose. There are three main types:

1. Sole proprietorship – This is the simplest and most common structure. The business and the owner are legally the same, with a sole proprietorship. This means that the owner is personally liable for any debts or lawsuits against the company.

2. Partnership – A partnership is similar to a sole proprietorship but involves two or more owners instead of just one. Like a sole proprietorship, the owners are personally liable for any debts or lawsuits against the company.

3. Corporation – A corporation is a separate legal entity from its owners. This means that the corporation can own assets, enter into contracts, and sue or be sued independently of its owners. The corporation is also taxed separately from its owners.

What you need to do to incorporate your business

You need to take a few steps to incorporate your business legally. Here is an overview of what you need to do:

1. Choose a business name – Your business name will be the name of your corporation. First, make a trademark search to ensure the name is available and not already taken by another company.

2. Speak with a lawyer – A lawyer will ensure you file your incorporation application and get set up correctly. 

3.  Do-it-yourself incorporation – People often make mistakes when they incorporate themselves.  It does save you some cash up-front since the filing fees are $350 in BC, but most likely, you will have to pay a lawyer to adjust your records.

The costs associated with incorporating a business 

When you incorporate your business, there are a few costs that you will incur. These costs can include filing, legal, and accounting. Make sure to budget for these expenses when you plan to incorporate your business.  Typical lawyer fees will charge around $1,500, and once incorporated, there will be annual legal filings and corporate tax returns.  The prices for these services range based on the complexity of your tax and legal situation.

How to get started with incorporating your business

Now that you know what is involved in incorporating a business, here is some advice on how to get started: 

Talk to an accountant or lawyer. The best way to learn about the incorporation process and what type of incorporation is right for your business is to talk to an accountant or lawyer specializing in incorporation law. They can walk you through the process and answer any questions you have. 

Do your research – There is a lot of information available on the internet about incorporation, so take advantage of these resources and learn as much as possible about it before making any decisions. 

The disadvantages of incorporation

1. Cost – Be prepared for the costs of incorporating a business, including filing, legal, and accounting fees. These costs can add up, so make sure you budget for them when making your decision.

2. Paperwork – Incorporating a business can be time-consuming and complicated, so you must be prepared to handle more paperwork. 

3. Extra tax filings – You must file a separate corporate tax return each year and your personal tax return.

When is the right time to incorporate your business? 

This is a question that many entrepreneurs ask themselves, and there is no easy answer. You need to consider several factors before deciding, such as whether you are ready to take on the added responsibility, whether you have the financial resources, and what type of entity you want to form. By researching and asking for professional input, you can make an informed decision that will be best for your business and future!

As a rule, from a tax perspective, we recommend that you incorporate once you earn more cash in your business than you need to personally spend in one year. Then, if you can leave most of your retained cash in your corporation, you will only be subject to corporate tax, which is lower than personal tax. This means you will effectively have more after-tax money to reinvest into your business.

If you are concerned about legal liability, we recommend incorporating your business. For example, a taxpayer who has significant personal assets and wants to start a business will want to ensure they incorporate so that they safeguard their personal assets.

What are the risks of incorporating

There are a number of risks associated with incorporating a business, including the following:

1. Complex regulations – Incorporating a business means following complex rules set by the federal government, which can be challenging to keep track of. You could face fines or other penalties if you don’t comply with these regulations. So long as you find a good accountant, you will protect the downside from this risk!

2. Increased costs – There are costs associated with incorporating a business, including filing, legal, and accounting fees. These costs can add up, so make sure you budget for them when making your decision.

Lastly, if you are a sole proprietor and decide to incorporate your business, educate yourself on the section 85 rollover and determine if it’s right for you.

Conclusion

When deciding whether or not to incorporate a business, there are many factors to consider. By researching and asking for professional input, you can make an informed decision that will be best for your company and future. Incorporating has both advantages and disadvantages, so it’s important to weigh all of the pros and cons before making a final decision. Incorporating a business is a big step, so it’s important to seek advice from experts who can help you navigate the process.

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