Small business owners often ask the question of whether they should incorporate or not. Unfortunately the answer is usually “it depends”.

Incorporation has many advantages including insulting your business risks, protecting personal assets from liability, a lower tax rate and allowing you to split income with family members involved in the business. There is also the possibility to sell the corporation down the road and not pay any taxes on the gain.

It has many drawbacks as well though. These include incorporation costs (expect a minimum of $1,000 for a basic incorporation), increased compliance costs every year (requires a separate tax return to be filed which is far more complex than your personal return and usually requires the assistance of an accountant) and requires a considerable amount of administration. Also, if your business loses money, the losses can only be used to offset income from the corporation (unlike losses in a proprietorship which can be used to offset other types of income, such as employment income).

Generally, the higher the net income of your small business, the more advantageous it is to incorporation. If you are a proprietor with a low risk business (meaning, the likelihood that somebody would sue your business is low) and you are earning just enough to live on, the additional cost of incorporation may not make sense. If you’re just starting out a business and you expecting to have losses initially, it usually makes sense to stay a proprietorship under you are at least profitable.

As a general guideline, if any of the situations below apply to you, it may be a good idea to look into incorporation further:

1. Your business is ‘risky’ in nature. For instance, if you are a food supplier, if there was ever an instance where your products made customers sick, you could get sued. If you are incorporated, liability is limited to the corporation’s assets. If you are not incorporated, you have unlimited liability so somebody could sue you personally and go after your personal assets such as your house.
2. You expect the value of your business to grow significantly and/or you expect to sell your business in the short to medium term at a gain.
3. Your business is earning more than $100,000 per year. The potential tax savings below this income level will be more than offset by the increased compliance costs to run the corporation.
4. Your business is earning more money than you need to live. Incorporating allows you to “manage your income”, meaning you decide when to pay yourself (and thus trigger personal taxes). There are substantial tax deferrals for leaving money that you don’t need in a corporation. If you are a proprietor, if you have an amazing year, you’ll pay tax on all the money you make, regardless if you need it or not.
5. You are thinking about taking out a loan. Generally, a lender views incorporating as a sign that you are committed to the business (even though they will probably ask for a personal guarantee depending on the situation) and will be more likely to approve financing.

These are just some considerations to think about when deciding if you should incorporate or not. If you are still unsure as to which way you should go, talk to your accountant or lawyer. The cost of making the wrong decision will be far more than a one hour meeting with your advisor to weigh the pros and cons.

If you are considering incorporation and would like to review your situation, we would be happy to sit down with you.