Should I incorporate my small business?

Contributors: Jordan Rowledge, Accountant and Mary Ann Donahoe, Tax Manager with MRSB Group

As small businesses grow, one of the most common questions owners are faced with is, "Should I incorporate?" There are a number of advantages and disadvantages associated with taking this step, which generally depend on the entrepreneur's individual preferences and current situation. The Globe & Mail last year published an informative article on the pros and cons of incorporation, which include added costs, potential tax benefits and liability issues. And yet, making the important decision to turn your company from a sole proprietorship into a corporation can depend as much on the type of business you run as on how much profit you bring in each year.

Before you jump in and decide that it's high time you joined the multitude of incorporated businesses out there, ask yourself a few questions that will help determine whether this really is the best choice for you.

What type of business are you operating and are there liability risks?

If you run a services-oriented company where there is the potential for your clients to hold you in breach of contract, the liability protection that comes with incorporating is probably worth the extra money you will spend doing so. Especially if you feel that you cannot afford to put your personal assets at risk for the sake of the business. Remember that under Canadian law, a corporation can acquire assets, be sued, enter into debt and commit a crime - just like an individual! However, the benefit of limited liability that comes with incorporation might be deemed irrelevant if your company is unable to secure a loan and the lending institution insists on personal guarantees from you, the owner.

How much revenue does the business bring in and are you able to income split?

One of the commonly assumed perks of incorporating your business is that you as the owner will be eligible for significant tax planning benefits. The truth of the matter is - that depends. There may be specific rules governing your business or profession that will determine whether you are eligible for tax savings. For example, the ability to split income with a spouse or adult child is one of the main benefits of incorporating, but professionals (e.g. lawyers, dentists) need to be aware of who is authorized to hold shares of a professional corporation; some provinces allow family members to hold shares, while others only allow members of the profession. Also, you should ask yourself if there is enough income to allow for splitting and will the tax savings outweigh the costs relating to incorporation? Another consideration is whether you are spending everything you make personally or are able to leave some of the earnings in the company, thus taking advantage of lower corporate tax rates. The Government of Canada recommends that business owners seek the advice of a lawyer or accountant to thoroughly assess the potential tax advantages incorporation can (or cannot) offer your business.

Do the financial and borrowing demands of your business warrant incorporation?

Now let's talk a bit about the costs associated with owner-operated businesses versus incorporated ones. The start-up and licensing fees associated with sole proprietorships are substantially lower than corporations, so this is a fairly straightforward tick against incorporation if you are just starting out as a business owner. However, corporations usually have an easier time raising capital than sole proprietorships, since incorporated businesses can typically borrow at a lower interest rate. In general, financial and lending institutions view corporations as less risky than other types of business so accessing funds may be easier. Of course, if you choose to incorporate you will likely require the services of a lawyer, accountant or both, so this is another cost to keep in mind.

These are just some of the issues to think about before you make the decision to incorporate your business. Whichever route you decide to take, doing your research and understanding the ins and outs of the process are crucial first steps. And remember, if you decide that now isn't the right time, it's possible that next year will be.