Should you incorporate your business?
Quite often, we are asked whether someone should incorporate his or her business that is currently a sole-proprietorship or partnership.
There is no straight answer for all situations as it must be determined on a case by case basis.
As a firm that specializes in small to medium Canadian corporations, we would like to offer our thoughts from a tax saving point of view regardless other issues you might have to consider such as liability and general costs.
A loss incurred from a business operating as a sole-proprietorship will be deducted from another source of income you earned. In turn, you will pay less income tax which will help your cash flow for your business. This can be more beneficial for a start-up business that normally would suffer a loss as opposed to making a gain in the first few years.
The income earned by your business will be added to your personal income and taxed at a personal level based on personal tax rates.
If you are currently earning an income and paying the marginal tax rate at the second bracket (2016 Federal rate 20.5%) or above, any added business income will be taxed at second or even third bracket (2016 Federal rate 26%).
The income you earned from the business operating as a corporation will be taxed at corporation tax rate as a separate legal entity. Currently a Canadian Controlled Private Corporation (CCPC) is taxed at 11% federally for the first $500,000 of taxable income.
Therefore, the income you earn through the business will not be added to your personal income and you would not have to pay more personal tax. Of course the corporation will pay the tax but at a much lower tax rate.
However, if you take the money out of the corporation, the money may have to be added to your personal income in the taxation year when the withdrawal incurred and you will have to pay the tax on it. As a result, there will not be much difference from tax saving point of view whether a business is under sole-proprietorship or corporation if this happens.
Our advice would be to keep the business under your personal income for tax purposes if you are expecting a loss and you have other income to support you, it is possible that you could pay less tax or get more of a refund to support your business.
Once your business gets stronger, you will most likely be expecting to pay at a higher marginal tax rate, and should think of incorporating your business at this stage. Some tax planning, in terms of how you could optimize your tax situation, would also be beneficial.