There are many factors to consider when deciding to carry on in a partnership/sole proprietorship or whether to incorporate.
From a marketing standpoint, incorporating might be a necessity. Some businesses are much more inclined to deal with an incorporated company. If that is not your case then you will want to consider the other implications.
The cost of incorporation and additional compliance costs of reporting for a company will offset some of the tax planning savings. Using the small business tax rate of 13.5% in BC is a good way to reduce your overall tax burden, especially if you plan on reinvesting the after-tax profits back into your business.
One potentially large cash flow bonus from using a company is the ability to bypass CPP premiums by issuing dividends instead of T4 management fees. Doing so can save approximately $5,000/year per shareholder that would have been issued a T4 at the maximum CPP coverage. One word of caution is to ensure you still make the minimum CPP contributions in order to keep your CPP disability coverage active. CPP disability has a minimum monthly payment and is an inexpensive form of disability insurance. If you don’t carry a separate policy or don’t qualify for another policy you will want to maintain the basic coverage at a minimum. Moreover, CPP premiums are for your retirement. They should not be considered a tax but rather a socialized RRSP program.
Another tax planning bonus is the ability to income smooth using a corporation. If you are in a line of work where your profits fluctuate wildly year-to-year, using a company to retain those profits and paying them out smoothly through dividends will help ensure you don’t exceed the highest marginal tax rate on your personal returns.
For a shareholder with a large family, you might also be able to optimize your personal income to maximize child tax, GST, and medical premium benefits. Taking out an interest bearing loan from your company and repaying it through dividends when the children turn 18 can provide huge benefits over the year. For this method to work interest rates need to stay relatively low and any future personal tax rate increases will negate some benefits.
Income splitting potential is another way to lower taxes between families members provided it is done correctly. Having various classes of shareholders enables dividends to be declared in accordance with each shareholder’s ability to absorb lower taxed income.
The capital gains exemption may be applicable when shareholders sell their business. When planned properly to avoid the alternative minimum tax, this exemption can protect large amounts of tax free gains. An individual may have a $750,000 gain tax free. Between husband and wife that can amount to $1,500,000.
Estate planning and the continuation of a business also benefits from utilizing a separate legal entity. In the event of the owner’s death, the business still carries one. Utilizing preferred voting shares is also a way to transition a company to ones heirs during their retirement phase. Should the company not be run effectively, the original owners can step back in and take over control of the business.
Past age 65 you will want to be cautious about your corporate savings. Old age security and the guaranteed income supplements are income based. If you are still withdrawing dividends from your corporation you may lose out on potential supplements and/or receive the old age security clawback.
A company is a separate legal entity and in some circumstances can provide shelter from potential liabilities*. If this aspect is of interest you should follow up with your business lawyer and insurance provider.
Solomon Nordine, BBA, MBA
Copyright © Complete Accounting Solutions
*NONE OF THE INFORMATION CONTAINED IN THIS ARTICLE IS FOR LEGAL ADVICE. YOU ARE ADVISED TO CONSULT A LAWYER WHENEVER CONTRACTUAL OR LEGAL ISSUES ARE CONSIDERED.