The decision whether to incorporate really encompasses an investigation of a whole range of factors: assessing potential tax savings, liability protection, creditor protection, and even the nature of your assets and other business endeavours. So there is no an easy answer. Couple that with the corresponding and sometimes off-setting disadvantages (such as added legal and accounting costs and complexity of your paperwork), and it becomes even more difficult.
So for the sake of simplicity, I’d like to boil it down to three considerations: tax benefits, liability protection, and end-game (i.e what are your goals?).
Taxation:
On the tax side, I will leave it to my accountant friends to dive in – but there are several really fun things to study here: claiming expenses, capital gains exemptions, taxable supplies, tax deferral and income splitting. My goodness I’m glad we have accountants! A couple of general comments to start your assessment:
Does the business earn more than you need to live on personally? if yes, incorporation may be right for you. For example, if the business earns $200,000 and you only need $80,000 to live on, you can take out the $80,000 via dividends and leave the $120,000 in the corporation for use later or for investing back into your business. That $120,000 is taxed at the lower corporate rate; so you have more 'after-tax dollars' to use than if you earned that personally.
Do you have family members that you can hire or get to do some work? if yes, incorporation may provide some benefits. You can more easily split income and tax plan by paying family members wages, for example, and deduct those against the corporation's expenses. Income splitting by dividends is also possible although special restrictions are now at play (again, a good accountant should be consulted on this).
Liability Protection:
If you buy shares in Apple or Coca-Cola, you do not take on any responsibility or obligation or liability that those companies may have - your liability is limited to the money you put in to buy the shares. That's true for small closely held private corporations as well. So running a business through a corporation instead of personally is a great way to creditor-proof your personal assets to some degree. A few comments here too:
You will likely be a Director too, and Directors CAN be liable for some things. See our blog post here for more on that.
There are some insurance offerings that can limit your exposure to business risks - general liability insurance can provide coverage for property or personal damages caused to third parties. So a corporation is not always necessary if insurance can cover the liability issues you are concerned about .
If the business needs to get financing, most lenders to small corporate businesses will ask for the Shareholders to provide personal guarantees - so you would have personal liability exposure to at least that one creditor in that case.
The End-Game
This is where, in my experience, most clients end up when processing this issue . . . there are several potential legal and business benefits to using a corporation in certain situations:
MULTIPLE OWNERSHIP: if there are more than three or four owners it might make sense to maintain ownership, management and governance of the business via the well-traveled legal structure of a corporation. A Unanimous Shareholder Agreement can be drafted to deal with contingencies such as death or default or other unhappy circumstance of co-owners. Running a business together as individuals could result in complex, costly, and unwanted legal headaches should those type of events occur. It is much more difficult to add or remove an owner, amend relative ownership positions, and transfer interests when a business with multiple parties is operating outside the context of a corporation.
MARKETING: for marketing purposes, there are those that see a distinct benefit in presenting a ‘professional’ face to the public with respect to customers, suppliers and others. Whether corporations are seen as more professional is a topic of debate – but many of our clients most assuredly consider it so;
DIVESTING: divesting and acquisition options may also be more numerous if your business is run via a corporation.
There are many other benefits – and disadvantages too. It is one of those stereotypical situations where we must, at the end of the day, simply advise that you contact your lawyer, accountant, and broker to get proper and detailed advice about your particular situation.
**Note: if you want this same question answered in the specific context of a real estate investment business, read this blog post instead.