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Why you should incorporate your small business or practise

January 2, 2012

I’m here to tell you that there might be a way to reduce the taxes you pay by incorporating your small business or practice. As a matter of fact, there are many reasons to incorporate. The main reasons are as follows:

1) Limited liability – when a business is incorporated, a separate legal entity is created. This new entity is considered to be distinctly separate from the owners/shareholders. The main result is that the owners/shareholders can only be held liable for the liabilities and wrongdoings of the corporation to the extent of the money invested. For example, if the corporation is sued for a large amount but the corporation can only afford a portion, the plaintiff can NOT go after the owner’s personal home or car. Note that in absence of legal incorporation, the owner would stand to lose personal assets since the business is considered to be a legal extension of the owner. This is a major reason for incorporation.

2) Raising capital is easier – without incorporation, owners raise money mainly from lenders like banks. Incorporation allows owners to more easily sell partial ownership to others in exchange for funds. Sale of partial ownership does not usually involve interest and is therefore more cost-effective relative to traditional debt.

3) Income control – in an incorporated entity, there is potential for reinvesting profits back into the business and not paying a salary or dividend to the owner. Since the owner may choose to reinvest the profits without taking a full salary or dividend, no taxes are due on the owner’s personal tax return in respect of the income since there is none. The result is that the owner can defer payment of income from the business and defer the taxes since they are not payable until the income is earned.

4) Income splitting – a corporation can be owned by family members even when they are not active in the business. A corporation can then choose to pay reasonable salaries to active owners and can choose to pay dividends to passive owners. Thus, an owner can redistribute income that would otherwise have been paid to him or her as salary or dividends to a spouse or children. Since the spouse or children would generally pay lower tax rates than the owner, the net family tax burden is lower resulting in a significant tax saving!

5) Small business limit – the taxes due on incorporated profits are generally lower than un-incorporated profits due to the preferred corporate tax rates levied on the first $500,000 of active income (in Ontario). The result could be a net savings of up to 30% on $500,000 or $150,000 of taxes! Note that the actual savings depend on many factors…

Incorporation is a simple and inexpensive process. It does involve annual tax return filing which leads to a slightly higher compliance cost relative to an un-incorporated business, but the above benefits are understood to outweigh the cost in many cases.

CRA will not permit the incorporation of “personal service businesses.”. These usually arise when there is no BUSINESS being incorporated but rather an EMPLOYMENT scenario is being incorporated whereby a regular employee decides to incorporate. There are enough punitive measures in place to ensure that it is more worthwhile to remain as an employee than to incorporate.

However, the CRA has specifically provided exclusions for the following individuals WHO MAY incorporate:

1) Lawyers and paralegals under the Law Society Act
2) Audiologists,
3) Chiropodists including podiatrists,
4) Chiropractors,
5) Dental hygienists,
6) Dental surgeons,
7) Dental technologists,
8) Denturists,
9) Dieticians,
10) Massage therapists,
11) Medical laboratory technologists,
12) Medical radiation technologists,
13) Midwives,
14) Nurses,
15) Occcupational therapists,
16) Opticians,
17) Optometrists,
18) Pharmacists,
19) Physicians and surgeons,
20) Physiotherapists,
21) Psychologists,
22) Speech language pathologists,
23) Respiratory therapists

#2 to #22 are under the Regulated Health Professions Act

24) Social workers and social service workers under the Social Work and Social Service Work Act
25) Veterinarians under the Veterinarians Act

Please let me know if there are questions or comments. I would be more than happy to discuss these matters in detail.

I can be reached at danielydiamond@gmail.com or in the office at 416 222 5555.

Danny

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From → Corporate tax

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