Floyd Oesch has seen both sides of the incorporation picture.
Now co-owner of Kelly's Kitchen, a family restaurant in Biggar, Sask., Oesch has learned that incorporation is sometimes a necessary part of running a small business.
"We incorporated from the start [of the restaurant]," he said. "For 10 years before that, we owned a retail greenhouse. Back then, we didn't feel we needed to."
Having shifted to a food service operation with more overhead, the change made sense from a money and liability perspective, Oesch said.
For a small business owner who likes to keep things simple, incorporation adds to the accounting complexity and costs, Oesch admits.
"I had to find an accountant that could do corporate returns, which meant having to go beyond the one we've used for the last 30 years," he said. "And you have to follow a lot of rules and regulations as a corporation."
At some point, any sole proprietor or small business partner will face the question of whether incorporation is the right thing to do.
Denise Wright-Ianni, a Toronto-based certified general accountant, says there are a number of reasons an individual might want to incorporate. These include:
- Limiting personal liability.
- Favourable tax treatment for active income earned.
- Possibility of capital gains deductions.
- Choice of year-end filing dates.
- Improved control over income earned by shareholders.
But there are also some headaches that come with incorporating, she says.
"Setup and administration costs are higher," Wright-Ianni said. "That includes filing fees, shareholder agreements and share structures, legal and accounting costs, ongoing administration, legal compliance and having to file separate corporate tax returns."
- Speak with a lawyer and a certified general accountant. Be clear about your intentions before filing anything.
- Determine your year end and try to incorporate around that time.
- Determine your shareholder agreements and share structures before filing your articles of incorporation.
- Set up corporate bank accounts and investment or loan accounts once you are incorporated.
- Contact the federal government to ensure you have an active business number (BIN) and apply for all other required numbers (GST/HST, import/export, payroll, etc.).
- File your corporate returns on time — check with a tax professional when your return will be due (generally six months following your year end).
- Ensure all other filings are completed on time: GST/HST, payroll remittances and slips, etc.
(Source: Denise Wright-Ianni, CGA)
For most people, tax savings and liability are top of mind when making the decision whether or not to incorporate. But aspects of revenue, personal lifestyle and tax requirements must also be taken into account.
"It usually makes sense from a cost-benefit standpoint if you are able to leave money in the corporation," says Carol Bezaire, vice-president of tax and estate planning for Mackenzie Financial in Toronto.
"If you can leave enough retained earnings in the business, then you have the benefit of paying a 20 per cent corporate tax rate. But if you have a straightforward business where your revenues and expenses cancel each other out, it's usually better not to incorporate."
With a corporation, owners can also choose to compensate themselves with a salary or take out dividends of retained earnings at preferred tax levels.
Bezaire cautions, however, that it's important to find the optimum mix of salary and dividend payouts since salary drives RSP contribution room and dividends don't.
Profit a must
There are other important guidelines to remember that make incorporation worthwhile.
First, the business must be able to make a profit.
"You don't want to spend the money on incorporating and have the business just sit there," said Bezaire. "Minimally, you want to start generating some income."
In addition, 90 per cent of income earned in the corporation has to be from an active business.
"If you fall offside, you won't qualify for the small business deduction and will end up getting taxed at a higher rate," Bezaire said.
"You can't set up a cabinetry business that makes $2,000 so you can move the value of your pension to the corporation. The [Canada Revenue Agency] will say that's not the real thing."
For anyone on the fence about whether to incorporate, Bezaire suggests they first answer the following basic questions:
- What is your tax bracket currently, and how much income tax do you pay? If you work and pay a lot of tax, it may be more efficient to open a corporation.
- How much do you actually need to live on? If you need everything you earn, then incorporating doesn't make sense.
- Are family members working with you? If you incorporate, you can take advantage of paying them dividends (non-minors only) and/or income splitting.
- What is the future of your business? Will it operate for a long time?
- What happens when it comes time to sell your shares? It's important to include succession planning in your considerations.
Given the choice, Oesch says he would prefer to revert to the simpler accounting of his unincorporated greenhouse business.
He also estimates that given the new venture's revenues, he won't see the tax benefits of incorporation for another three to four years.
But he also understands that, this time around, incorporating was the sensible thing to do.
"I wouldn't say it wasn't worth it," Oesch said.