You have started a new business and are excited about the obstacles and opportunities that are before you. You have a vision to execute a product or service to market and you have officially embarked on the journey of an entrepreneur. Business licenses are in place and your operation as a sole proprietorship is in motion. How do you decided when or if you should incorporate the business?
A Sole Proprietorship has the following benefits and drawbacks:
- You are the SOLE owner of your business – this is typically a positive, however, you also take on ALL responsibility for the business.
- You keep all the after tax profits.
- You are personally liable for all business debts that the company may or may not incur.
- You have the ability to make decisions on behalf of your company WITHOUT the approval of shareholders or board members.
- You have the ability to keep costs LOW and utilize business losses from personal income to keep personal income tax low. The reverse is also true, all profits are taxed at your personal tax rate.
- RISK – You are FULLY liable
- In a sole proprietorship, more profitability = more taxes.
Fast Forward
Your business has grown. You have multiple staff, overhead and revenues that exceed your expenses. What is your best course of action? As you consider incorporating, there are a few key indicators that will help you make your decision:
- If your business is earning more than it needs to fund your lifestyle, then this is a good sign to incorporate.
- If there is significant liability in running your business, incorporating can provide limited liability. Limited Liability simply means that the owner’s private assets are less at risk if the company fails or someone sues the company than in a sole proprietor structure.
- Corporate taxes are lower than personal taxes. Small business taxes (profits of less than $500k) are significantly less than personal taxes (which can be as much as 42.5% less). The government does this to incentivize business owners to re-invest in their company. It can also provide opportunity to utilize a potential future tax deferral.
- Dividends can be taken out of a corporation with preferential tax treatment.
- Incorporating provides the potential to be eligible for lifetime capital gains exemption through share sale.
There are many factors to consider when determining whether it is the right time to transition from a sole proprietor to a corporation. Both routes can be a viable option. It is important to consider the future growth, goals and succession of a business to make the decision that’s appropriate for you.
I recommend discussing the different options with your advisor to determine when incorporation makes sense for you.
