Should you consider incorporating your business?

From a tax perspective, there is little advantage to incorporating a business unless the business has significant after-tax retained earnings at the end of each tax year. If a business owner requires all of the net business income to offset personal expenses and lifestyle needs, there will be no tax advantage to incorporation as all income withdrawn will be taxable at the shareholder-owner’s own marginal tax rate (MTR.)

Retained earnings

There are significant advantages however where business earnings are retained within the business, either to be reinvested in an effort to grow the business or to generate income that may be taxed at the preferred small-business rate; after claiming the Small Business Deduction for qualified Small Business Corporations – for the 2010 tax year and forward, a favorable combined corporate tax rate as low as 13.5% on the first $500,000 of eligible active business income is achievable.

While the tax benefit created as a result of the Small Business Deduction is considered a deferral of tax and not necessarily a reduction in tax, the principle of time-value suggests it is always best to pay tax obligations with future depreciated (as a result of inflation) dollars. Further by paying a lesser corporate tax up front, more capital is available for immediate reinvestment within the corporation; meaning a greater benefit to the corporation is realized.

• More information on Canadian corporate income tax rates and small business income theresholds can be found at the following webpage published by KPMG.

Capital Gains Exemption

Upon the sale of qualified Small Business Corporation shares, a lifetime capital gains exemption of up to $750,000 may be claimed and offset taxable capital gains otherwise payable. Private corporations may be (re)structured to allow for income-splitting opportunities with family members and Trusts as well as provide for estate and succession planning goals...more

Liability protection

Because an incorporated business is a legal entity and is separate from shareholder owners, potentially a limited personal liability exists to the extent of his/her (actual) investment in the business. This benefit may also extend to other shareholders; who may or may not be family members. In circumstances where a personal guarantee is (often) required by a creditor (lender or supplier for instance,) no such liability protection exists and the shareholder-owner and the corporation itself shall be jointly liable.

Registration & Legal

Legal requirements related to registration and initial set-up (legal and registration) costs as well as annual reporting and tax filings make incorporation somewhat more cumbersome and expensive than a Sole Proprietorship and/or Partnership. These (additional) costs should be weighed against both the scope and size of the business opportunity and prospective net business earnings as well as related benefits as defined above.