To incorporate or not to incorporate; that is truly the question. There are many benefits of incorporating, both tax and non-tax related; including those that will increase your bottom line!
Non-Tax Benefits
Separate Legal Entity:
When you incorporate, the corporation ceases to be a direct extension of the owner. Unlike a sole proprietorship or partnership, a corporation is a separate legal entity with its own rights and obligations. A corporation can acquire assets in its own name and incur debts in its own name. This legal distance between the owners and the corporation itself can be very advantageous, as you will see when limited liability is discussed below.
Limited liability:
In some partnerships or sole proprietorship, the owner of the business is completely liable for all of the debts of the business. This places a very onerous obligation on the owner. However, in a corporation, the liability of the corporation’s owners (i.e. shareholders) is limited. This means that, as a general rule, the owners of a corporation, so long as they do not have an additional role within the corporation (e.g. director), are not responsible for the corporation’s debts. In other words, a shareholder cannot lose more than the investment made into the corporation, and they are not responsible to creditors directly.
Raising Capital:
As an owner of an unincorporated business, your typical method of raising more funds to carry on operations usually comes in the form of debt, such as loans. Incorporating opens up new avenues in which you can raise the raise funds to expand the business. Corporations have the benefit of being able to issue shares in exchange for money. Rather than incurring a debt which needs to be repaid, you can sell a share of your corporation in exchange for capital. Shares are often more attractive to investors than loans, which makes this a tremendous benefit.
Tax Benefits
Lower Corporate Tax Rates
As mentioned above, corporations are a separate legal entity from their owners. Whereas the owners of sole proprietorships and partnerships are taxed directly for the income earned by these entities, owners of corporations are not. Rather, corporations are taxed separately from their owners. And, since the corporate tax rate is generally lower than the individual tax rate, incorporation may offer you some cash flow advantages.
Small Business Deduction
The Small Business Deduction is possibly the greatest benefit given to those who incorporate. In Canada, if you, as most private corporations in Canada do, qualify as a Canadian-controlled private corporation under s. 125(7)of the Canadian Income Tax Act, s. 125(1) reduces the amount of tax your corporation is required to pay by giving it a deduction. Currently, after applying the Small Business Deduction, the corporate rate in Ontario is about 15.5%.
When preparing the corporate income tax return, a Canadian-controlled private corporation claiming the Small Business Deduction would calculate its allowable Small Business Deduction by multiplying the Small Business Deduction rate by the least of the following amounts:
- the income from active business carried on in Canada;
- the taxable income; or
- the business limit
Subsection 125(2) defines the “business limit” as $500,000. As a result, unlike in a sole proprietorship or partnership, a corporation gets a significant monetary advantage on up to the first $500,000 in income it earns.
Do you want to take advantage of the benefits of incorporation? Is incorporation right for you? The tax professionals at Tax Doctors Canada are experts on incorporation and corporate tax, and are waiting to hear from you.
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