When to Incorporate? Part 1

In my last blog we discussed Why Incorporate?  This completely ties into when to incorporate as you will see from this blog.  There is no absolute answer to “When to Incorporate?” as everyone’s situation is different, however these are some general guidelines to help you know when it’s right for you to incorporate.  Let’s look at the 3 reasons that people incorporate and how they tie into when to incorporate.

The first is tax savings as incorporations that earn active income receive what’s called the Small Business Deduction which allows Corporate Income taxes (Federal & Provincial combined) to be as low as 14% in Alberta (currently). This low tax rate on active income earned in a corporation is static up to $500,000 active net business income.  Once you make over $500,000 in a corporation you pay a significantly higher tax rate, but most corporations will never need to go over $500,000 in net income (after expenses).  If you see in your projections that your corporation will exceed $500,000 it is essential that you plan in advance to look for ways to avoid this.  For example you may structure 2 separate, non-related, corporations to provide 2 separate products or services your one corporation may have provided so each could stay under the $500,000 Small Business Deduction Limit.

Individuals, on the other hand, have what’s called a Graduated Tax system, which means there are tax brackets that make individuals earning more income pay higher rates of tax.  There are various levels that trigger the higher rates of tax, and there are even personal tax exemptions that allow you to pay no tax if you have very low income.  This is why a lot of people start as sole proprietors because they will pay less personal tax as sole proprietor that earns up to about $30,000 of net income (not including income splitting in Alberta).  Once you make about $30,000 in your corporation it changes and you can now save more tax using a corporation.  This is because shareholders of the corporation can receive about $30,000 in tax free dividends from a private corporation before paying tax if this is there only source of income.  Not only is there no personal tax on the dividends, but also no EI or CPP.  This means at around $30,000 you typically only pay the corporate taxes at a lower rate, even if you (the shareholder) has pulled out all of the $30,000 made in profit.  There is one more factor to consider: Accounting Costs!  Accounting Costs for a corporation are much more than individual costs as there both Federal and Provincial Tax returns that must be done for a corporation and they are much more complex than personal tax returns.   Not to mention full accounting must be done for corporations, including assets and liabilities, and financial statements are prepared, along with schedules and minutes for the corporation’s minute book.  Although you are saving tax at $30,000 net, if you include the accounting fees against the savings you are looking at incorporating around $35,000 net to save taxes (including accounting fees).  This way you will be saving more than you pay the accountant! At Kustom Design our goal is to always save you more than you pay!

Please check back for the next installment of the “When to incorporate” blog series.