One of the best ways to make your
accountant cringe, is to inform him or her that you have recently started
a business and that you have already incorporated the business. However,
once your accountant recoils, you too may soon be cringing when he
or she informs you how incorporating the business may have just cost
you thousands of dollars.
Unfortunately, most people hold the
common perception that incorporating a business is always the best
way to ensure a full range of deductions for income tax purposes and
often circumvent proper tax planning by automatically incorporating
their business.
If incorporation is not required
to eliminate your personal liability, the following income tax considerations
should be taken into account prior to incorporating your business.
(1) Do you anticipate start-up losses? If the answer is yes, you will,
in most cases, be better off not to incorporate, since you can use
these losses against your other income on your personal income tax
return. If the business subsequently becomes profitable, you can
transfer the business to a corporation on a tax-free basis (professional
advice should be sought before doing this).
(2) Do you require the funds earned in the corporation? Although
in most cases the tax rate for a corporation will be lower than for
personal tax purposes, this remains so only as long as the funds
remain in the corporation. This tax deferral is eliminated or reduced
once the funds are paid out as salary or dividends.
(3) Do you wish to have the flexibility of paying salaries or dividends?
By incorporating a business you have the choice to pay salaries or dividends.
This can be an important advantage, since the optimal salary/dividend mix
can result in reduced taxes in certain situations.
(4) Do you wish to involve your family in the business? Family participation
in a business is usually easier when a corporate form is used, especially
if the initial capital is minimal.
(5) Do you intend to be an employee of the corporation? Employees and shareholders
of corporations may be eligible for certain housing ( recently restricted
by Revenue Canada) or car loans not available to unincorporated businesses.
(6) Do you see the potential that your business
will grow substantially? If you meet certain criteria and sell your corporation's
shares, you may be entitled to a special $500,000 capital gains exemption
that is not available to unincorporated businesses.
Although the above
list is in no way exhaustive and not all the above factors enter into
each decision to incorporate, it should be clear that the decision
to incorporate should not be made without considering your entire
personal and income tax situation. It is advisable to consult an
accountant before making the decision.
