To incorporate or not – that is the question.

Posted: February 15, 2013 in Business startup
Tags: ,

I deliver business classes to aspiring entrepreneurs and it never ceases to amaze me how people are led to believe that the “Ltd” suffix after a business absolves them of all liability. Not so!

A corporation can be an evolution in the phase of a business. The business grows nicely (both revenue and profitability) and tax consequences make it necessary for owners to incorporate. There are advantages to incorporation:

  1. The liability for trade creditor obligations rests with the corporation. The liability is limited to the debt owed by the company to the trade creditor. The proprietor owns the assets of a proprietorship and is liable personally for the trade creditor obligations.
  2. There is an opportunity for a business owner to generate wealth from holding common stock in a corporation – if the corporation grows. Paper equity accretes. On the other hand, the wealth of a proprietorship is restricted to goodwill only – the net present value of the customer list in essence.
  3. The income of the corporation is taxed at corporate rates that are amongst the lowest in the OECD countries. The corporate tax rate in Canada is between 20-22%. A proprietor’s business income is taxed at rates that could approach 46%  in Ontario.
  4. Small business corporations have a $500,000 income threshhold, below which they are entitled to the federal small business deduction. There is no such threshhold for proprietorships. This is a major benefit for small business corporations with assets under $2 million and revenue of $5 to $8 million.
  5. Contractual obligations can be entered into by a corporation. The benefits and liabilities accrue to the corporation. A proprietorship can enter into a contractual obligation but, the proprietor is listed as a signatory to the deal.
  6. A shareholder can receive both salaried income and dividends to minimize their personal tax burden. A proprietor’s income is a direct computation:  revenue less business expenses = business income. The T2125 form is appended to the T1 return. This business income is taxed at marginally increasing rates.

There are more advantages to incorporation. However, my next post will explode a few myths about the “limited liability” aspect of incorporation.

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