Should I incorporate? This is the question I get asked the most by business owners whose side hustle has grown beyond part-time. The majority of businesses start out as a side hustle. You have an idea or talent, then friends find out about it. It’s not long before you’re making a bit of cash on the side. Work at it for a year, and you are now booked up every weekend or working evenings to meet the demand.
Fast forward 3 years. Now your side hustle has turned into a full-time gig, and you’re making decent money at it. So at what point should you incorporate? Let’s first have a look at the reasons most businesses incorporate.
Incorporating – What are the Benefits?
The main financial benefit is that the corporate tax rate is much lower than the personal tax rate in Canada. For example, assuming your business has earned less than $500K in its fiscal year, a $150,000 salary would be taxed at around 16%. However, if that same $150,000 were taken personally, it would be taxed at about 46%.
Business owners have the ability to decide how much they want to take out of the company and the two main ways that this is achieved are salary or dividend. As a sole proprietor, you are taxed on the total amount of your net profit. So, for example, if your net profit is $150,000, you will be taxed about 46% because it is considered personal income.
Limited liability gives protection of a Shareholder’s personal assets if the company goes bankrupt. In addition, limited liability ensures that the shareholder only loses what they have invested in the company if financial hardship arises.
For example, if the shareholder invested $15,000 into the company and it went bankrupt and owed $100,000, the shareholder would only lose the $15,000 they invested. No creditors could come after the personal assets of the shareholder. The same goes for if you are sued by an unruly customer.
As an unincorporated company, all your personal assets would be at risk if it went bankrupt or you were being sued.
Separate Legal Entity
What does this mean? In Canada, a corporation is viewed as a separate legal entity. Which means it has its own rights under the law. It can enter into contracts, own property and investments and start legal proceedings against another entity. In other words, the company is separate from its shareholders. Shareholders do not personally own property within a corporation. Assets are owned by the company until its dissolution, at which time it would be divided up between shareholders, creditors or sold off.
Better Business Image
Let’s face it. Corporations look more solid to consumers than unincorporated businesses. Therefore, many potential consumers would rather purchase from corporations because they have a more sturdy foundation.
That’s not to say that sole proprietors do not have solid foundations. But corporations usually have put a lot of resources behind product guarantees, refunds, policy, and privacy.
If you are a business and hire a corporation-they cannot be deemed an employee by CRA. Which happens a lot when companies hire independent contractors or sole proprietors. There are special restrictions around a subcontractor being an employee or not. For more information on this subject, check out https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/rc4110/employee-self-employed.html.
It is also easier to market the corporation, find work, and attract investors. In addition, because the incorporation can hold investments, they can easily sell portions of their stock, offering exit strategies to protect both sides.
So what are the Cons?
You may be thinking, “Wow! This is great; let’s incorporate!” But there are some disadvantages to consider.
Big Brother is more interested in a corporation and therefore puts many more restrictions on what you need to report to CRA. Once incorporated, you will need to complete a corporate tax return at the end of each fiscal year. CRA will also want to know if there are any changes to the business address, shareholders, and the registered office where your books are kept.
You will also need to file an annual report on your fiscal year-end anniversary each year. This costs about $45. Along with a minute book for meetings, you will need to keep the government updated on certain corporate records such as Director registries, Shareholder Registries, and resolutions.
Costs of Incorporating
The costs of incorporating are considerably more than running a business as a partnership or a sole proprietor.
By the time you add up the NUANS name search, incorporation fees, and the professional fees for legal services, you have added up quite a bit. You’re looking at $1,000 and up depending on the size of the company and the structure. Corporate tax returns will run at around $1,000 to $4,000, depending on the company’s complexity.
So, after all that information-at what point do I incorporate my small business?
In reality, there is no magic number of revenue that says you must incorporate or not.
If your business revenues are more than you need to live a comfortable life, it might be time to incorporate and take advantage of the tax deferral. For example, for some businesses, if your revenues are $60,000 to $100,000, incorporating would be the best idea.
Favourable tax rates on dividends, dividend splitting, and lower corporate tax rates would outweigh the additional accounting and legal costs.
On the other hand, if you are just making ends meet financially with your business, it would be best not to incorporate until you have more net income.
Still hesitant? If you want to grow your business and hire people or are netting more income than you need to live off, a corporation is the better structure.
If you’re not sure if it is worth your while, feel free to contact us at firstname.lastname@example.org, and we will try to answer any of your questions. Need help with incorporation? Check out our Services page and get in touch!
Finances for a Modern World
I’m a bookkeeping technology geek who has been in this industry for over 20 years. My specialty is helping small business streamline their workload with paperless business systems.
I have also worked as a purchaser and a controller for several businesses. Currently I am Advanced Certified in Quickbooks and a variety of accounting programs.