When to Incorporate? Part 2

Here is the 2^nd and last installment of the “When to incorporate” blog series.

On the previous blog, you will notice that when we spoke of the $30,000 of tax free dividends, we stated the fact “if this is your only source of income”  If you have other sources of income the $30,000 (approx.) is not tax free, but you will pay some tax at a lower rate.  The reason why you always pay a lower tax rate on dividends from Canadian corporations is because of the dividend tax credit that you get when claiming dividends on your personal tax return.  If you have other sources of income, particularly large amounts of income, you may want to incorporate earlier.  As discussed, when you set up a corporation you are forming a new entity.  This is a separate entity from you and therefore the income of the corporation does not go on your personal taxes unless you receive or claim income from the corporation.  This differs greatly from a sole proprietorship where you and the business are one in the same for income and liability purposes.  So again, if you have other sources of income you may want to incorporate for tax savings before you are netting $35,000 so as to keep corporate income separate from your personal income that may be in a higher tax bracket.  When in doubt on this one, come see us and we can run scenarios to see when you will start saving tax with a corporation.

The second and third reasons of “When to Incorporate?” are much simpler, yet can take serious thought and consideration!  The second is liability. If you have major liability potential in the product or service you are providing, you may want to incorporate right from the beginning of the business so as to take as the least amount of personal liability.  You may also want to look at trusts and holding companies that we will discuss in other blogs.  You must always asses your potential liabilities when starting any business. 

The third reason is to make your business attractive.  As discussed in the last blog if you want to make your business attractive you should look at incorporating.  If you are going for it 100% and you expect to do well quickly then you may as should look at the option of incorporating right from the beginning!

Watch for my next blog where we will begin discussing the structuring of a corporation.

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.