Forming Your Business - Should I Incorporate?
Should I incorporate?
You need not incorporate. Your business can be carried on as a sole proprietorship, partnership, limited partnership, or corporation. Each has its advantages and disadvantages.
Using a sole proprietorship:
This is the simplest arrangement. All benefits and debts will be yours personally. The income or loss will be included in your personal income tax return, which can reach a maximum combined federal and provincial rate of about 50 per cent.
You can’t pay yourself a wage or salary as an employee of the business, because the law won’t let you make a contract with yourself.
You may need a licence to carry on your business. Municipalities licence electricians, plumbers, restaurants, taxi cabs, convenience stores, driving schools and various other activities. The Province licenses employment and personnel agencies, motor vehicle dealers, real estate brokers and securities dealers. The Federal government also licenses some businesses.
If you carry on business under a name other than your own, you must register it with the Ontario Ministry of Consumer and Commercial Relations. Registration is for five years and it may be renewed.
Using a partnership:
If you carry on business together with another person or company for profit, you are considered partners. A partnership is like a proprietorship in that each partner is directly involved in the business; a partner cannot pay himself or herself a wage or salary, because the law sees it as making a contract with oneself.
Most partnerships are “general” partnerships, in which liability is unlimited, and all benefits and debts are the partners’ personally. Ontario recognizes another type of partnership—the “limited partnership”, which requires special registration. In a limited partnership, the liability of one or more of the partners is unlimited, and the liability of one or more of the other partners is limited to the amount which those partners contributed to the business.
In all partnerships, each partner is the agent of the other partners when acting in the “normal course of partnership business”. Only when it is apparent that a partner is not acting for the partnership will one partner not legally bind the others.
Using a corporation:
A corporation is a legal entity separate in law from its owners. The shareholders own the corporation, but not its assets and liabilities. This means that a shareholder’s liability is “limited” because, should the corporation’s liabilities become greater than its assets, the creditors of the corporation cannot claim the balance owed from the shareholders themselves. The shareholders will, at most, lose only the value of their shares.
However, in a small business, lenders, such as banks, often insist on receiving guarantees from shareholders over and above any guarantee from the corporation, particularly if the corporation has few assets of its own. In such instances, the shareholders lose their limited liability regarding those debts.
Which form of business is best?
What is your business plan? Will it be just yourself? Will others be sharing the risks and rewards? Are you concerned about liability if your business makes a mistake or if someone is harmed?
One advantage with a corporation is income splitting and estate planning. You can have different classes of shares, leaving yourself control of the business by retaining the voting shares, and leaving the income generating or capital appreciating shares to others in your family.
Your company may qualify for the “small business deduction”. If so, it will be taxed at about one-half the regular rate on the first $200,000 of active business income in each year.
One disadvantage with a corporation is that it costs more to incorporate and more to maintain annual corporate records and tax filings. Another disadvantage, if you anticipate a few years of losses before turning a profit, may be the difficulty of bringing those losses into your current personal income tax return (which could offset other earnings from another job or profession).
Partnerships, including limited partnerships, are often used to create so-called “tax shelters”. This is because net tax losses or large tax deductions associated with the nature of the partnership can “flow-through” to the partners and so reduce the individual investor’s taxable income from other sources.
Please give us a call, and we can talk about what is best for your business.