Every small business person considers whether or not to incorporate
his business at some point. The form of a business isn’t immutable; you can change the legal structure of your business as it grows. A common scenario is for small businesses to start out as sole
proprietorships or partnerships and become incorporated at some later date when the business has grown.

Incorporate your small business

If you’re one of the people considering incorporating your business, here are the main advantages of incorporating:

  1. Limited Liability

The main advantage to incorporating is the limited liability of the incorporated company. Unlike the sole proprietorship, where the business owner assumes all the liability of the company, when a business becomes incorporated, an individual shareholder’s liability is limited to the amount he or she has invested in the company.

If you’re a sole proprietor, your personal assets, such as your house and car can be seized to pay the debts of your business; as a shareholder in a corporation, you can’t be held responsible for the debts of the corporation unless you’ve given a personal guarantee.

On the other hand, a corporation has the same rights as an individual; a corporation can own property, carry on business, incur liabilities and sue or be sued.

2. Corporations Carry On

Another advantage of incorporating is continuance. Unlike a sole proprietorship, a corporation has an unlimited life span; the corporation will continue to exist even if the shareholders die or leave the business, or if the ownership of the business changes.

3. Raising Money Is Easier

Corporations also have more ability to raise money, which may make it easier for your business to grow and develop. While corporations can borrow and incur debt like any sole proprietorship, they can also sell shares and raise equity capital, a big advantage because equity capital generally does not have to be repaid and incurs no interest. (Of course, by issuing shares, you are reducing your percentage of ownership in the company.)

4. Income Control

If you incorporate your small business, you can determine when you personally receive income, a real tax advantage. Instead of getting your income when it’s received, being incorporated allows you to take your income at a time when you’ll pay less in tax.

5. Potential Tax Deferral

Becoming incorporated gives you tax deferral potential. Because you can defer paying some tax until a later time, you may be able to realize tax savings if you are then in a lower tax bracket, or if the tax rates have fallen.

6. Income Splitting

Another tax advantage of incorporating is income splitting. Corporations pay dividends to their shareholders from the company’s earnings. A shareholder does not have to be actively involved in the corporation’s business activities to receive dividends. Your spouse and/or your children could be shareholders in your corporation, giving you the opportunity to redistribute income from family members in higher tax brackets to family members with lower incomes that are taxed at a lower rate.

Incorporating your small business sounds like a great idea, doesn’t it? But there are also disadvantages to incorporating that you need to consider.

1. Another Tax Return

When you incorporate your small business, you’ll have to file two tax returns each year, one for your personal income, and one for the corporation. This, of course, will mean increased accounting fees. Unlike a sole proprietorship or partnership, corporate losses can’t be deducted from the personal income of the owner.

2. Increased Paperwork

There is a lot more paperwork involved in maintaining a corporation than a sole proprietorship or partnership. Corporations, for example, must maintain a minute book, containing the corporate bylaws and minutes from corporate meetings. Other corporate documents, that must be kept up to date at all times, include the register of directors, the share register, and the transfer register

3. No Personal Tax Credits

Another disadvantage of incorporating is that being incorporated may actually be a tax disadvantage for your business. Corporations are not eligible for personal tax credits. Every dollar a corporation earned is taxed. As a sole proprietor, you may be able to claim tax credits a corporation could not.

4. Less Tax Flexibility

A corporation doesn’t have the same flexibility in handling business losses as a sole proprietorship or a partnership. As a sole proprietor, if your business experiences operating losses, you could use these to reduce other types of personal income in the year the losses occur. In a corporation, however, these losses can only be carried forward or back to reduce the corporation’s income from other years.

5. Liability May Not Be As Limited As You Think

The prime advantage of incorporating, limited liability, may be undercut by personal guarantees and/or credit agreements. The corporation’s much vaunted limited liability is irrelevant if no one will give the corporation credit. When a corporation has what lending institutions consider to be insufficient assets to secure a loan, they often insist on personal guarantees from the business owner(s). So although technically the corporation has limited liability, the owner still ends up being personally liable if the corporation can’t meet its repayment obligations.

6. Registering A Corporation is Expensive

A further disadvantage of incorporating is that corporations are more expensive to set up. A corporation is a more complex legal structure than a sole proprietorship or partnership, so it’s logical that creating one would be more complicated and costly. Fees for incorporating a small business either provincially or federally range in the hundreds of dollars – and that’s just for the set up. I’ve already mentioned the increased maintenance and related fees, such as increased accounting costs.

Should you incorporate your small business? I’ve outlined the advantages and disadvantages of incorporating in this article, but I strongly recommend that you discuss your personal situation with your accountant and lawyer before you decide. He or she will be able to give you a much more exact picture of how incorporation could benefit your business, and help you see whether or not the trouble and expense of incorporation will be worth it to you.

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