Should you become a personal corporation?
What is better for your business – a personal corporation or sole proprietorship? The short answer is it depends. For many small to medium business owners, incorporating yourself may seem like an extra cost. However, there are many benefits to incorporating yourself. Aside from signalling to the market that you are serious about your business, the benefits include insulating your personal life from business risk, optimizing your personal taxation and deferring income.
In Vancouver, it is extremely common to see people in the real estate sector working under personal corporations. Other common professions that find benefits in personal corporations are physicians, dentists, engineers and architects. All of these professions typically bring in big dollars, and spend less than they earn. In this case, a personal corporate will allow these people to keep their earnings in the business, away from taxation and will allow them to pay themselves in the most tax efficient manner.
Pros of personally incorporating
As touched on above, personal incorporation has a number of pros associated. The most important benefits of personal incorporation all relate to taxation. At the basic level, personally incorporating optimizes your tax rate if you are a high earner.
According to Brad Blair, a financial advisor in Vancouver,
By personally incorporating, you are able to shield your income from personal taxes. By keeping the bulk of your earnings invested in your personal corporation, you are able to defer income tax. This has huge benefits for individuals in the upper income brackets, who typically save more than they spend.
In addition, by running your earnings through your corporation you can choose the most tax efficient method of paying yourself. This can be through dividends, a salary or bonuses. All other earnings that you do not need to spend can be parked in your corporation.
Additionally, incorporating allows you to sell shares of your company. This has the obvious benefit of opening a new revenue line for yourself, as you grow your business. As you move towards retirement, having the option to sell off parts of your business can help you grow your retirement income and make the transition process even smoother.
For individuals just starting a business that have yet to earn large amounts, personally incorporating has some benefits as well – the ability to insulate yourself against business risk. Personal corporations enjoy what is known as limited liability. This means that if any actions are raised against the company in question, your personal net worth is shielded from legal claims.
All of these benefits are great for business owners and should be considered by any high-income earner. However, nothing comes without drawbacks, so here are the Cons of personal incorporation.
Cons of personal incorporation
The #1 drawback of personal incorporation is the costs. There are legal fees and registration fees, which can run upwards of $2,000 in Canada. Registering a name is $30 in British Columbia, and incorporating the business costs $300. Once you mix in legal fees to ensure that everything is in order, the costs can be much higher.
Technically you can incorporate yourself for $1,000 but it is usually well worth the extra money to hire a lawyer and an accountant to ensure that everything is correct.
Operating a personal corporation also costs more money as well. You need to file paperwork, including separate tax filings, income statements, share files and other notices. There is no doubt that operating as a personal corporation steps up the level of complexity of operating your business.
Additionally, you are limited in the losses that you are able to claim. You are no longer able to personally claim your losses – just as your liability is limited to the amount that you invested, so are your claims to losses. This means that if your business is failing, you are not able to write off your losses for that year beyond what you had invested.
When to personally incorporate?
It becomes worthwhile to begin considering to personally incorporate once your after tax earning raise above $90,000 a year. There are some benefits to incorporating before that point if you are operating a unique business model that may have some legal risk attached. Some Internet start-ups for example may want to consider incorporating early if they fear that they may be encroaching on a legal grey zone.
If you are making above $90,000 you are nearing the top tax brackets in Canada and will be able to find significant tax efficiencies by incorporating. Additionally, at that level it is likely that you are not spending most of your earnings and thus, paying personal income tax at the highest bracket on those earnings is not tax efficient. Personally incorporating will allow you to segment your income into smaller tax brackets and save you money in the long run.