In this article, we're going to explore the key points you need to know before incorporating that will help save you thousands.
We'll discuss the potential benefits of incorporation but also the risks and costs that could sneak up on you if you're not careful.
So, whether you're just starting out or thinking about taking your business to the next level, this article is for you. It could save you thousands by helping you avoid some common, yet costly, pitfalls.
Deciding Whether or Not to Incorporate
Let’s start by assessing your business goals.
Understanding the goals you want to achieve with your business can guide whether or not to incorporate.
Making the right decision here can save you a lot of money.
I’ll take you through an exercise that involves asking yourself ten questions about your business and your intentions for it.
Incorporation Questionnaire
Grab your copy of our incorporation questionnaire and follow along.
Your answers to these questions will help you better understand whether incorporation is a reasonable route for you.
The worksheet will automatically tally up your answers and should make your decision more clear.
Let’s get on to the Incorporation Questions.
Or if you would rather hear it from Joe, check out this video 👇
Incorporation Questions to Ask Yourself
1. Your Plan for the Business
The first question is about your plan for the business.
Ask yourself:
Do you plan on building your business into something that is more than just self-employment?
If you want to grow it into something bigger with a team and operations at a larger scale, then this points more towards incorporation.
2. Legal Liability
The second question to ask yourself is:
Does your business have significant potential for legal liability?
Incorporating can provide some protection against liability.
So if you’re in a higher risk business like construction or transportation, then incorporating could be more attractive.
3. Expected Earnings
Question three is a fun one.
Do you expect your business to earn more net income in a given year than you might use personally?
Incorporation can provide some flexibility for when and how you pay yourself. This gives you options that can help you to defer paying tax on income until a later date.
If you expect to earn more income than you might personally use each year, then that is another point in the incorporation column.
4. Outside Investment
Next up, it’s time to think about investment in your business.
Ask yourself:
Do you plan on, or would you like the option of having others invest in your business?
Corporations provide more ways for others to invest in your business compared to running an unincorporated business.
A yes here points towards incorporation.
5. Selling the Business
Question five requires a bit of forward-thinking.
Ask yourself:
Do you plan to sell the business in the future?
If the answer is yes, or even maybe, then incorporation could be the right move.
Selling your incorporated business in Canada could give you access to the lifetime capital gains exemption. This allows you to sell the business at a gain of around one million dollars without having to pay a cent of tax! Pretty cool.
Alright, moving on to questions six through ten.
These will look and sound a little different than the first set.
6. Just Want to Be Your Own Boss
Question six is next. Please ask yourself:
Is the main purpose of your business so you can be self-employed, as opposed to building a business that involves others?
If you just want to be your own boss but don’t have intentions of growing the business further than just yourself, then an unincorporated business may be better.
7. Annual Upkeep Costs
Next question is about the cost of incorporating.
Ask yourself:
Does the annual upkeep cost of approximately $3,000 - $5,000 outweigh the potential benefits of operating as a corporation?
If that cost sounds too high compared to the benefits of incorporating, then that might be a good indicator for you that an unincorporated business is a better option.
8. Losses in the First Year
Next question:
Do you expect to have significant losses in the first year or years of the business?
If you’re just getting started and you expect to have more expenses than revenue in the first year, then you may want to delay incorporating.
This isn’t a really big factor, but you can offset personal income with unincorporated business losses in the year that they happen.
If you’re operating as a corporation, then the losses would get carried forward and applied against future corporate income.
It’s just a matter of being able to use losses now compared to using them later with the corporate route.
9. Simplicity
Question nine is all about simplicity.
Ask yourself:
Is simplicity in bookkeeping and taxes a priority for you?
And really we could apply this to compliance in general. If you value simplicity over the potential benefits of incorporating, then that may point towards an unincorporated business.
10. Testing a Business Idea
And lastly, ask yourself:
Are you mainly testing the waters for a business concept and unsure about its long-term viability?
If the answer is yes, then it could be a better idea to wait and see if your business is viable before jumping in and incorporating.
Incorporation Questionnaire
Alright, if you’ve followed along on the worksheet linked below, then you should have a count of your “Yes” answers.
You should see a score for incorporating and one for running an unincorporated business.
Disclaimer
Now, this is just a guideline and you shouldn’t just count them up and make a decision based on total score.
For example, for the incorporation questions, you might have a single yes in that you plan on selling the business.
The potential tax savings from using the lifetime capital gains exemption is huge and is certainly worth more than many of the other criteria.
The point of the worksheet is not to just count up the totals and pick that option. It’s there to help you think about the decision and to outline some of the reasons why you might want to incorporate vs not.
Save Money When Incorporating Your Business
Alright, next up let’s assume that you’ve decided to incorporate your business.
We’ll take a look at the potential pitfalls that can arise during the incorporation process and how to avoid costly mistakes there.
Options for Incorporating
Incorporating your business can be done in several ways, each with its own set of advantages, disadvantages, and costs.
Here’s how you can decide between doing it yourself, using online services like Ownr, or hiring a full-service law firm.
DIY Incorporation
First up is DIY incorporation. Many provinces in Canada have an online service that will allow you to file your own incorporation documents.
This is the least expensive option, with costs mainly consisting of government filing fees, which typically fall in the range of a few hundred dollars.
Of the three methods, DIY incorporation is the most cost-effective. However it can be quite time-consuming and comes with a higher risk of mistakes if you're unfamiliar with the legal requirements.
It also lacks any personalized legal advice.
DIY incorporation is a reasonable option for simple business models or when budget constraints are tight, and you have the time to research and understand your legal requirements.
Online Incorporation Services like Ownr
The next method is basically a DIY method but on a single, comprehensive platform that also offers support.
The cost is typically less expensive than a law firm but slightly more than the DIY option. Prices vary based on the service package, but typically range from $400 to $700.
It’s great for the fact that it’s more affordable than full-service law firms. It’s user-friendly, automated and you have the option of receiving some basic support.
However, it’s less personalized than a full-service law firm and likely won’t cover all unique legal needs or complex structures.
It’s a great option for small businesses with relatively straightforward legal needs that want a balance between cost, convenience, and access to some guidance.
Our affiliate link here 👈 will provide 20% off your incorporation costs with Ownr
Full-Service Law Firm
And our last option is incorporating with a full-service law firm.
This is the most expensive option, with costs often ranging from $1,500 to several thousand dollars, depending on the complexity of the incorporation and rates of the firm.
It’s great in that you get personalized legal advice, expertise in handling complex situations, and comprehensive service.
However it is easily the highest cost option and might be unnecessary for simple incorporations.
This option is best for businesses with complex legal needs, significant investment, or those planning rapid growth and expansion that may require detailed legal and tax planning.
And, it’s our preferred method when you need to complete a Section 85 rollover. In other words, you have been running your business as a sole proprietorship for a while and need to transfer assets into the corporation.
Or it might also be your best option if you just want a bit more hand-holding and peace of mind.
Cost of the Wrong Decision
Making the wrong choice in how to incorporate can lead to unnecessary expenses, either upfront or in the long run.
Overpaying for a simple incorporation can eat into your initial capital, while underestimating legal needs can result in costly restructuring or legal fees later.
My official advice is to ask your accountant and lawyer what their recommendation is and take that into consideration.
Understanding Corporate Share Structure
Once you’ve chosen how to incorporate, you have a couple of other decisions to make.
The first is what your share structure will look like.
It’s a lengthy topic that we’ve already covered in our corporate share structure article.
However, it’s important to consider who will be involved in the business, what rights you want them to have and how you plan on distributing income from the corporation.
Getting this wrong could mean you need to pay a lawyer AND an accountant to help you restructure the company down the road.
Jurisdiction of Incorporation
Your next choice relates to WHERE you want to incorporate your business.
You have the option of incorporating in your province or territory, OR you can choose to federally incorporate.
Provincial / Territorial Incorporation
Incorporating provincially means your business is recognized and protected within the specific province or territory of registration and is subject to local laws and regulations.
It’s typically best for businesses that intend to operate primarily within a single province or territory, offering simpler regulatory requirements and potentially lower costs.
It’s often not the best choice for businesses aiming to expand nationally, as name protection and corporate recognition are limited to the province or territory of incorporation.
Federal Incorporation
On the other hand, Federal incorporation allows your business to operate under a name recognized across Canada. Your company would then be governed by the Canada Business Corporations Act.
This option offers wider corporate name protection and a more established presence nationwide.
It’s a great choice for businesses planning to operate in multiple provinces or territories, or those looking to expand their reach across Canada in the future.
However it may be unnecessary if your business will strictly operate within one province or territory.
This method of incorporation requires compliance with both federal and local regulations, which can increase complexity and administrative tasks.
Taking the time to plan ahead can help you choose the appropriate jurisdiction and avoid costly fees related to moving your company to another jurisdiction.
Save Money After Incorporation
Ok, so we’ve reviewed decision criteria and some pitfalls related to the incorporation process.
Lastly we’ll look at some issues that can arise once you’ve incorporated and are running your business.
Ongoing Obligations and Compliance of Corporations
Once your business is incorporated, it enters a new phase of legal and financial responsibilities.
Compliance with these obligations is a critical aspect of maintaining your corporation's good standing and avoiding penalties.
Legal and Tax Filings
Corporations are required to file annual tax returns, regardless of their operational status.
This includes financial statements and corporate tax filings, which can be more complex than personal tax returns.
Record Keeping
Corporations need to maintain detailed records of their financial transactions, director and shareholder meetings, and corporate decisions.
Penalties for Non-Compliance
Failing to meet these obligations can result in fines, penalties, and interest charges. In severe cases, it could lead to the dissolution of the corporation.
Paying Yourself from Your Corporation
And as a business owner of a corporation, you’ll probably want to pay yourself!
You have two primary ways to pay yourself: salary or dividends.
Each method has its own set of implications for personal income taxes and corporate compliance.
I’ll give a quick overview of both, but you can always check the video linked in the description for our full rundown.
Salary
Drawing a salary from your corporation means you become an employee of the company.
This requires setting up a payroll system, remitting source deductions to the government, and issuing T4 slips annually.
This can increase administrative work and potentially your accounting fees when running your company.
Dividends
On the other hand, dividends are paid out of the corporation's after-tax profits and are taxed at a lower rate on an individual’s income tax return.
Filing a T5 slip annually is required to report these dividend payments.
While dividends require less administrative work compared to a salary, they don’t offer some of the same benefits as paying yourself as an employee.
Costs of Mismanagement
Choosing the wrong method for your situation, or failing to meet the associated administrative and filing requirements can lead to tax inefficiencies and penalties.
For example, late source deductions or misfiled documents can result in quickly escalating fines and interest charges.
Again, if you want more info on paying yourself from your corporation, check out the link in the description below.
Lifetime Capital Gains Exemption
And lastl but definitely not least, it’s important to talk about a major source of potential tax savings, the lifetime capital gains exemption.
The lifetime capital gains exemption allows some Canadian business owners to sell the shares in their company at a gain of up to $1 million before owing any tax. It’s pretty amazing.
However, if your incorporated business is not set up properly, you won’t be eligible to claim it.
For this reason, it’s important to start planning at least two years out before selling your business.
It’s best to consult with an accountant and a lawyer when you’re getting ready to sell. Hundreds of thousands of dollars may ride on making sure the business is eligible.
More information on the LCGE can be found in our video linked below.
How Much Could You Save?
Alright, let’s put it all together and look at how much it could cost you if you chose… POORLY.
Or let’s put a more positive spin on it and let’s look at how you could SAVE by making the RIGHT decision!
I don’t want to keep you here for hours, so we’ll just look at a few scenarios.
Just Want to Be Your Own Boss
First up, the scenario where you just want to be your own boss.
In this case, if you decide not to incorporate, you could save anywhere from $3,000 to $5,000 per year from avoiding corporate upkeep costs.
There are still costs related to running an unincorporated business, but they’re generally lower.
Cost Savings for choosing correctly? Around $3,000 per year.
Legal Liability
For legal liability, I’m not even going to estimate the cost.
If you are unlucky enough to be sued in your business, you’ll probably still have to pay lawyers regardless of whether you’re incorporated or not.
The main point is that incorporating can provide some protection against liability.
Cost savings $$$$$… I'm not sure how to estimate that, but it has the potential to be a lot.
You Earn More Than You Need
Next up, the scenario where you earn more income in a year than you need personally.
In this case, if you aren’t incorporated, you might be forced into the highest tax bracket for the year.
This means you could pay tax on a whole bunch of income at tax rates of over 50%.
Let’s say you live in Ontario and earn $500k but you only needed $200k for the year.
Without incorporating, you would pay around $231k in tax!
If you were incorporated and only withdrew the $200k that you needed for the year, your total tax would be around $107,000.
Now the $124,000 difference doesn’t actually mean tax SAVINGS; think of it more as tax DEFERRAL.
The CRA will get their tax eventually!
Lifetime Capital Gains Exemption
And lastly, if you were eligible for the lifetime capital gains exemption and sold your business at a gain of $1 million, you would pay a whopping $0 of tax on that sale.
On the other hand, you would pay more than $200k in tax if you sold an unincorporated business for a similar gain.
That’s a big penalty for making the wrong decision, so definitely keep that one in mind!
Final Thoughts
Ok, time to wrap things up. We've journeyed through the critical aspects of incorporating your business, from the initial decision-making process to understanding the ongoing responsibilities.
By carefully considering your business goals, legal liability, earning potential, and long-term plans, you can make an informed choice that aligns with your vision and saves you money.
Take the time to understand each step, consult with professionals when needed, and plan accordingly to make the most of your business structure.
Thanks for joining me in this discussion and don’t forget to grab your copy of the incorporation questionnaire below.
