The advantages of staying small
For small businesses with minimal profit, incorporation is not worthwhile
When small business owners ask Diana Dolack whether they should incorporate, she often advises against it.
"There's not too many I advise to incorporate," says Dolack, an H&R Block franchise owner in Biggar, Sask. "For farmers, especially, the rules are more beneficial to not being incorporated."
The formula for Dolack is quite simple.
"If you need to spend all your profit to live on, then you don't need to incorporate because you have nothing to shelter," she said. "A corporation is a lot of extra paperwork, higher accounting fees and takes a lot of extra time."
Once incorporated, a business is a distinct entity from the business owner. The corporation has its own legal status, property, rights and liabilities. It differs from a sole proprietorship in that the money and other assets belong to the corporation, not the individual or shareholders, and it is taxed separately at a corporate tax rate.
A business can be incorporated federally or provincially depending on where it operates.
Ron Ellis, a criminal defence lawyer based in London, Ont., says he's often asked about incorporating but still hasn't taken that step.
"I'm 44 years old, recently into the practice of law as of 2004, and only been a sole practitioner since 2006," Ellis said. "And while my practice is growing nicely, I have two kids in university so am assisting with funding. I need all the money I make right now. But I expect in time, I will be in a better position to incorporate as I expand."
Dolack agrees it's a good idea to test your business for a couple of years before deciding whether to incorporate.
"If you start by incorporating and decide to quit in a year or two, there's a structure you have to deal with and a cost associated with deregistration," Dolack said.
Keeping it simple
For the thousands of sole proprietors or partners out there who choose not to incorporate, a big motivation is keeping the tax work as simple as possible, said Christopher George, founder of Christopher M. George Chartered Accountant Professional Corporation in Toronto.
"There are less tax-compliance issues and fewer returns to file," George said. "And it's cheaper — about $75 — to just register your business as a sole proprietorship or partnership. Incorporation could cost you north of $1,000."
As an unincorporated proprietor, tax filings are simply a matter of filling out the T2125 Statement of Business and Professional Activities form and including it with your personal tax return.
"You put it on your personal return, and you're done with it," George said.
"Most people just don't have the technical ability or time to prepare financial statements, balance sheets, income statements and all that goes with it."
Of course, avoiding the paperwork and costs of incorporation does not mean underestimating the value of good accounting practices.
For many sole proprietors who do their own taxes, it's important to know what you can deduct — and how much. More often than not, George says, those proprietors aren't deducting enough.
"Usually, their expense claims are way too low," he said. "I've seen people claim only $35 a year for their cellphone, or underestimate their car expenses. Or I see someone with a wife and two kids that isn't taking advantage of income splitting. People just don't seem to understand what reasonable expenses are."
There are, of course, the usual deductions: any advertising (websites, newspapers, etc.), business meals, entertainment, insurance costs, and interest on loans relating to your business, as well as car and office expenses.
If you run a home office, you can claim a portion of your home expenses, including mortgage interest, home insurance, utilities and renovation costs.
Also, don't forget business travel expenses, including cellphone and internet charges.
"What I encourage people to do is to track everything they spend when travelling and have a checklist to see what types of expenses can be written off," George said. "Then, you just add your receipts and fill in the boxes."
When in doubt, he recommends dividing expense items by revenues to see if the percentages being claimed are reasonable. For example, if you have revenues of $100,000 and $3,000 in meals and entertainment expenses, that translates into an acceptable three per cent.
"If those expenses were 20 per cent of your revenues, then your tax return might get pulled aside," said George.
Income splitting is also a good way to optimize your tax dollars, George said.
"Be careful with that, since you have to show that what you paid a family member is reasonable for the work they have done," he said. "If you're paying someone $275,000, that's going to cause the Canada Revenue Agency to take a look."
If you have purchased a car, you can deduct a capital cost allowance for depreciation, as well as an appropriate percentage of gas, loan interest, insurance, licence, registration and maintenance costs.
In the case of leasing, you simply write off a percentage of the lease amount along with the day-to-day running expenses. In order to support the claim and ensure percentages are accurate, the Canada Revenue Agency advises professionals to keep a logbook that records kilometres driven for business purposes.
While some self-employed individuals avoid seeking professional help to save themselves costs, fees usually end up being less than the extra taxes saved, George says.
"A one-hour consultation will give you a good understanding as to how everything works, what can be claimed or not," he said. "You could end up savings tens of thousands of dollars over your lifetime."