Should you incorporate?

The other day I was chatting on the phone with a friend and she asked me if she should incorporate her business because her insurance company recommended she incorporate her business to get a lower premium. I told her there are multiple facts to look at before incorporating as there are a lot of responsibilities when you incorporate. However, because she is saving an insane amount of money on her insurance premium, I told her she should incorporate. Although at the time my friend thought it was a great idea, she is now feeling the pain of having a corporation. Before going into detail of how painful it is, let's define what is a corporation and what are the differences from a sole proprietorship.

An incorporated company is a legal entity, just like a person, who has the right to do anything other than get married. It has the right to enter into agreements with other parties, buy, sell, own property and capital. It is completely independent from the owner(s) meaning this form of entity also protects somewhat the owners from bankruptcy and legal actions towards the company. When a corporation prepares its income tax return (T2), it prepares it's own tax return independently from the owner(s). The owner(s), own shares and the number of shares allows votes, these votes influences who decides what. The more votes you have, the more power you have when making a decision. If you own more than 51% of the votes, you are the major shareholder and when you take a stand on a decision, the company has to follow your command.

There are two ways to incorporate, federally and provincially. If you incorporate federally, you can operate anywhere in the country and have the corporate office anywhere in Canada. On the other hand, a provincial corporation can do the same, operate anywhere in the country, but the headquarter has to remain in the province it incorporated in. If the headquarter moves out of the province, the company is considered dissolved and it's operations terminated.

To compare to a sole proprietorship to a corporation, a sole proprietorship is the owner operating the company and is responsible for filing his personal income tax and fulfilling it's legal obligations. If something happens to the company, the owner will be held accountable as he is the company. When filing his taxes, the owner enters the business income into his income tax return (T1), filing a T2125. The income from the T2125 is then added to his taxable income.

So if a corporation is completely independent from the owner(s), that means it has to prepare and file it's own income tax and fulfil its own legal obligations. This is where most people get confused. The company now has the obligation to maintain its books independently from the owner. It implies it has to prepare a set of financial statements. The company will have to prepare a balance sheet, where we see the assets, the liabilities and the owners equity, and an income statement, revenue minus costs providing the net earning. On the other hand, a T2125 (required for a personal tax return) only requires a company to prepare an income statement, the balance sheet is not an obligation.

So to get back to my friend's pain. She now has to do bookkeeping, learn what is an asset, a liability, sales and costs. in reality, she now has to learn accounting. She now has to submit a form 22, an annual return, annually. File GST/HST and payroll remittance, if it's the case, on behalf of the company. She also has to have a tax return prepared by an accountant as she has no clue what is a corporate tax return or even how to file one. A corporate tax return is also much more expensive than a personal tax return. Therefore, she has to pay more money to have it filed. And the last and not least, now she has to prepare board minutes and board resolutions when making decisions that effects the company. All of this to gain a lower insurance premium that could save her thousand of dollars.

Although its sound complicated and a lot of work, there are more to just negative elements. Below, are the added values of having a corporate entity:

1. If the company files bankruptcy and the owner hasn't guarantied any loans, the owner is protected against bankruptcy.

2. The owner is protected from legal action towards the company.

3. In case the owner(s) passes away, the entity is still active and may keep operating until it is dissolved, if it's the case. The decease mays transfer his/her shares to someone else.

4. Assets in a corporation are protected from personal bankruptcy. For example, let's say the company owns a car. If the owner files bankruptcy personaly, the car is protected from the creditors as it is own by the company.

5. The incorporated entity benefits from lower tax rates, moreover the company benefits from small business deduction on taxable income on earnings lower than $500K.

6. As long as the money stays in the company, the owner doesn't get taxed on personally.

7. There are additional ways to access or raise capital like issuing shares and creating financial instruments, as an example, asset backed commercial paper.

8. The credit rating of a corporation is different than a personal credit score. Therefore, the corporation can benefit from lower borrowing rates.

To sum it all up, if you have significant assets and you would like to protect these assets or you are planning to obtain large amount of debt and you want to protect yourself from bankruptcy then incorporation is good for you. If you barely have any transactions and don't have the money to pay for accountants, bookkeepers and tax experts, I don't recommend getting incorporated yet. Wait until the benefits outweigh the negatives like savings on insurance premiums and protect yourself from property damages to others that could lead to lawsuits, then go ahead and incorporate. To be safe, you could always ask an expert on the matter.