Should You Stay Unincorporated or Incorporate Your Business?

When starting a business, one of the fundamental decisions you’ll need to make is whether to operate as a sole proprietorship or incorporate your business. This choice affects everything from your liability and tax obligations to your ability to raise capital and plan for the future. Understanding the key differences between staying unincorporated and choosing to incorporate can guide you to make an informed decision that aligns with your business goals and personal risk tolerance.

Sole Proprietorship: Simple and Direct

• You Are the Business: In a sole proprietorship, there’s no distinction between you and your business.
• Simplicity: It’s easier and cheaper to set up and manage with less paperwork and fewer legal requirements.
• Taxes: You report business income and expenses on your personal tax return.
• Liability: You are personally responsible for all business debts and liabilities, putting your personal assets (like your house or car) at risk if your business owes money or gets sued.

Incorporating: Creating a Separate Entity

• Separate Legal Entity: Your business becomes a separate legal entity, meaning it can own property, enter contracts, and be involved in lawsuits independently of you.
• Limited Liability: Your personal assets are generally protected from business debts and liabilities. You only risk the money you’ve invested in the business.
• Costs and Complexity: Incorporation involves more paperwork, higher setup costs, and ongoing regulatory requirements like annual filings and maintaining corporate records.

Tax Benefits of Incorporating

• Lower Corporate Tax Rates: Canadian-controlled private corporations (CCPCs) can benefit from a lower tax rate on the first $500,000 of active business income.
• Income Splitting: If family members are shareholders, the corporation can pay dividends to them, potentially reducing the overall family tax burden.
• Tax Deferral: Corporations can retain earnings within the company, allowing you to defer personal taxes until the money is withdrawn.
• Lifetime Capital Gains Exemption (LCGE): When you sell shares of a qualifying small business corporation, you may be eligible for a significant tax break on the sale.
• Business Expense Deductions: Corporations can deduct a wide range of business expenses, including salaries, bonuses, and benefits to employees, reducing taxable income.
• Access to Grants and Incentives: Incorporated businesses might have access to specific grants, subsidies, and government programs designed to support corporations.
• Succession and Estate Planning: Incorporating can provide more flexible options for transferring the business to heirs or selling it in a tax-efficient manner.
• Health and Life Insurance: Corporations can provide tax-free or tax-advantaged health and life insurance benefits to employees, including owners.

Transitioning from Sole Proprietorship to Incorporation

If you are currently operating as a sole proprietor and are considering incorporation, here’s what the transition typically involves:

1. Choose a Business Name: Your corporation will need a unique name that complies with your jurisdiction’s naming rules. It’s advisable to check the availability of your chosen name before proceeding.
2. File Articles of Incorporation: Prepare and file the necessary incorporation documents with your local government or corporate registry. This includes choosing a corporate structure and defining the share structure.
3. Create Corporate Bylaws: Establish the rules and regulations that govern your corporation’s operations. These are usually detailed in the corporate bylaws.
4. Register for Taxes: Obtain a new tax identification number for your corporation. You’ll need to register for corporate taxes and, if applicable, payroll taxes and sales tax.
5. Transfer Assets: Move your business assets from your sole proprietorship to the new corporation. This might include transferring property, contracts, and intellectual property. It’s important to document these transfers properly.
6. Update Contracts and Agreements: Notify clients, suppliers, and other business partners about the change in business structure. You may need to update contracts and agreements to reflect the new corporate entity.
7. Open a Corporate Bank Account: Establish a separate bank account for your corporation to keep business finances distinct from personal finances.
8. Obtain Necessary Licenses and Permits: Ensure your new corporation has all the required licenses and permits to operate legally in your industry and location.
9. Inform Stakeholders: Notify employees, customers, and other stakeholders about the change in business structure. Transparency helps maintain trust and smooth transition.
10. Compliance and Record Keeping: Maintain proper corporate records, hold annual meetings, and file annual reports as required by law to stay compliant.

Key Considerations

• Size and Growth: If you plan to grow your business significantly or seek outside investment, incorporation might be beneficial.
• Risk: If your business involves high risk or significant debt, incorporation can protect your personal assets.
• Tax Planning: Incorporating can provide tax benefits, but if you plan to use all the corporation’s profits personally, the tax advantages might be less significant since you’ll pay personal taxes on those profits.

Conclusion

Staying unincorporated is simpler and cheaper but comes with personal risk. Incorporating provides protection and potential tax benefits but involves more complexity and cost. Consider your business size, risk level, future plans, and personal use of profits when making your decision. Consulting a tax professional can help you understand the specific benefits and obligations in your situation. Transitioning from a sole proprietorship to a corporation requires careful planning and execution, but it can position your business for greater growth and security. Contact us if you have any questions!