Here at Kane Shannon Weiler LLP, one of the most common questions our corporate lawyers get asked is, “should I incorporate?”
To answer that question properly, we should start at the beginning.
What Does Incorporating Mean?
Incorporation is the process of setting up a corporation, usually a company or a society. The rules around setting up a corporation in BC are set out in the BC Business Corporation Act. It’s also possible to set up a corporation federally under the Canada Business Corporation Act.
For the sake of keeping things simple, we’re just going to talk about setting up a company in BC.
Advantages to Incorporating
Creating a Separate Legal Entity
One of the main benefits to incorporating is that it creates a legal separation between you as an individual and your business. For example, your company’s revenue will not be on your personal income tax, and your company’s debt will not count as your personal debt.
If you have not incorporated and are working for yourself, you are probably a sole proprietorship. This means that you can be held personally liable for everything your business does, because you are your business and your business is you. This means that if your business owes money to someone, they can come after your personal bank account to collect.
Since your company’s creditors can only claim your company’s assets and not your personal one, companies have “limited liability,” which is why some company names end in “Ltd.” or “Limited.” On the flip side, as a sole proprietor your business’ creditors can come after your personal assets as well as your business assets, making it “unlimited liability.”
With a sole proprietorship, since you and your business are one and the same, the second you stop working is the second your business ceases to exist. Your kids cannot take over the family business if *you* are the family business.
If you incorporate, your company can continue operating long after you retire. This is attractive for a few reasons. One reason, as already mentioned, is that you have the possibility of keeping the business in the family if you want your kid(s) to take over. Another reason is that if your business continues to operate after you retire, you could continue to collect dividends if you keep your shares in the company.
It is easier to raise capital through a corporation. Through a corporation you can sell shares of your company to investors. Investors typically buy “preferred” shares in a company which generate a return on investment through guaranteed dividends. This is known as “equity capital” because you are raising money based on the value of your business and the investor’s belief that the business will continue its success enough to be able to keep paying out dividends.
It is also possible for corporations to raise capital through debt, by entering loan agreements. A business loan works just like any other loan, in which you borrow money that you have to pay back with interest.
Disadvantages to Incorporating
Unlike a sole proprietorship, which is free, incorporating costs money. Not only at the start when you initially file your documents, but also on an annual basis as you need to pay the government an annual maintenance fee. On top of that, you will have additional administrative costs, such as separate tax returns and financial statements for your company.
Things to Consider
If You’re Concerned about Liability
You should certainly incorporate if you are concerned about liability. Incorporating can protect you in most cases from being held personally liable for debts or obligations of your company.
If You’re Concerned About Tax Savings
If your business is generating more money than you need for your lifestyle, you can likely save money by incorporating. Let’s say you only need $80,000 per year to keep up your lifestyle, but your sole proprietorship generates $200,000 per year. Without incorporating, your personal income tax will be based on the full $200,000, resulting in approximately $69,000 of personal tax.
Alternatively you could incorporate and earn business income through a company. The first $500,000 of business income earned in a company is taxed at a low preferential rate of 11%. If you incorporate and leave $120,000 in your company and pay yourself $80,000 your overall tax would be approximately $33,000 of corporate and personal tax, resulting in a tax deferral of approximately $36,000.
If You Want to Sell Your Business Eventually
As a sole proprietorship you could sell all of your assets when you decide it’s time to move on, but there are things you can’t sell, such as any contracts you entered for the business, including employment contracts.
With a corporation, you can sell the entire thing, including its name, goodwill, and the contracts with employees and clients will remain intact since the contracts are with the corporation, not with you personally.
When deciding whether or not to incorporate your business there is a lot to consider. If after reading this article you are still unsure what the right choice is for you, come talk to us!
The business law team here at Kane Shannon Weiler LLP is more than happy to answer your questions and help guide you to making the right decision for your business.
Note to our Readers: This is not legal advice. If you are looking for legal advice in relation to a particular matter, please contact us.
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