Article by Jonathan Wright. Click here for homepage.
Most businesses reach a point where this becomes an important question: whether or not it’s time to incorporate. There are costs involved but the tax and legal benefits can be significant for business-owners and even professionals like real estate agents, dentists and doctors.
The purpose of this note is to tease out some of the benefits of incorporation to see whether it makes sense for you. Read on, or (if your time is short) click here for a brief, one-page chart on the benefits of incorporation, holding companies and income splitting.
At the time of writing, the small business rate for corporations is 13.5%. Compare that to the top tax rate for individuals of 47.7% and you can see why incorporating might make sense.
To be clear, the government receives its share. When a shareholder takes her dividend from the corporation, she pays tax on the dividend essentially equal to her individual marginal rate minus the tax already paid by the company. As a result, if a person is taking out of her business all the income it makes in the year (say, to pay down her mortgage), tax deferral won’t provide much benefit yet. However, if the shareholder is able to hold off on receiving the cash, perhaps reinvesting profits back into the business, this tax can be endlessly and wonderfully deferred.
The small business rate isn’t available for all corporations. However, carry on an active business (providing services say, or selling products) or have sufficient employees in your passive business and this rate should be available to you.
A corporation is a separate entity—another “person” in legal speak.
This means that if the corporation is carrying on a business and runs into a problem (your widget injures a customer or a bank calls in a loan) the liability stops at the corporate level. The creditor might sue for the company’s assets but it won’t have access to those of the shareholder, like her home or cottage. There are exceptions to this (fraud being a glaring example or when a shareholder guarantees company debt), but the general rule is that liability doesn’t pass through the corporation.
This might be the most significant benefit of incorporation currently available and can be combined for even better results with a family trust.
Income splitting with a spouse as an employee is available before incorporation, but pay must be reasonable. If a business-owner pays her spouse $200,000 to do bookkeeping for five hours a month, this may be flagged by the CRA and the deduction disallowed.
On the other hand, income splitting through a company isn’t subject to reasonability requirements. If the company is set up properly the company can issue dividends to whomever the director chooses, including spouses and children over 18, and in whatever amounts.
Add a family trust into the mix and you can have one individual in full control of the company, while at the same time being able to income split as desired. This control keeps the equity of the company in the hands of the trustee, protecting it from potential creditors like the divorced spouse of a child.
Lifetime capital gains exemption
I’ve covered this area in more detail in an article I wrote recently. In brief, every Canadian has a lifetime capital gains exemption which is indexed to inflation ($824,176 at the time of writing) on the sale of shares of a corporation. There are certain requirements that need to be met but, if satisfied, the result is that on the sale of your company, $824,176 in gains is exempt.
Bring in other shareholders, whether directly or by way of trust, and this exemption can be multiplied. For example, a company owned solely by a trust with four adult beneficiaries would have an exemption of nearly $3.3 million.
Certain professionals (including lawyers, doctors, dentists and real estate agents) are permitted to incorporate under their professional legislation and thus have access to the benefits above. However, these professional corporations must meet legislated standards, including requirements with regard to incorporation documentation and restrictions on shareholding. We here at Wright Legal have experience with these requirements and dealing with the various governing bodies and would be happy to assist you as necessary.
Time to incorporate?
If you are considering whether incorporation makes sense for you or are looking for tax advice on whether setting up a trust or holding company will be beneficial for your business, please do not hesitate to contact the author at firstname.lastname@example.org or 604.678.4459, or visit our main page at wrightlegal.ca.