Structuring your Corporation part 1

There is so much to consider in structuring a corporation and this blog will definitely not be able to cover all the considerations and options for structuring, nor should this blog be misconstrued as legal advice.  That said, in this blog series I will give you a lot of very useful information and tips on structuring corporations.  Because this blog series is on corporations, we will not be going into any great detail on the various other entities and contracts you can use in your structure, such as trusts and Limited Partnerships. 

There are virtually unlimited options when it comes to structuring your corporation as there are many different classes of shares within multiple categories.  The different classes of shares are in letters, such as class A shares, class B shares, class C shares, class D shares etc.  The 3 main categories of shares are:

1. Voting Shares – Used for the main shareholders with voting rights
2. Non Voting Shares – Used for other shareholders with no voting rights
3. Preferred Shares – Shares with preferred treatment, typically used for attracting investors or in restructuring existing corporations

Let’s start with some basics that you should know in structuring a corporation.  First you should always consider making both you and your spouse a shareholder in your corporation if you are married.  In making both spouses a shareholder you are opening up the door for income splitting the profits of the corporation through dividends.  Being a shareholder does not mean liability is taken, in fact it is typically the director that would take all liability of the incorporation as we’ve discussed in a prior blog.  So both spouses can be shareholders and receive benefit, while only one spouse could be a director taking the liability on.  It is always good to keep one spouse sheltered from liability. 

We’ll continue our blog series on “Structuring your Corporation” on my next blog post.

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.

Why Incorporate?

There are many reasons to incorporate, which really break down into 3 areas.  The 1^st area is tax savings.  Corporations can save taxes in many ways and we will go deeper into the area of tax savings throughout this series of blogs.  Corporations can pay as little as 14% total federal and provincial tax on active income up to $500,000 in Alberta.  All provinces and territories across Canada have attractive tax savings at different levels using corporations.  You can also avoid payroll remittances and extra costs such as EI and CPP with the utilization of dividends.  Shareholder loans are a very powerful tool of a corporation and are tax free.  You can sell assets to the Corporation at Fair Market Value and receive the amount now or in the future from the corporation tax free.  As you will see throughout this series there are many ways to save and defer taxes through a corporation.  In the next series we will discuss when to incorporate and part of this will include the timing of incorporation for tax purposes, which in Alberta is about$30,000 - $35,000 net income if this is your only source of income.  If you have other sources of income or if you corporation will grow quickly, then you may want to incorporate right from the start.  We will discuss this in my next blog.

The 2^nd area of reasons to incorporate has to do with liability protection.  When you incorporate you set yourself up for limited liability. Unlike partnerships where partners are usually personally liable for the business acts of their partners, corporate shareholders are typically not personally liable for the acts of the directors, officers or other shareholders of the corporation.  The director takes the liability and that is typically only liability for anything that is personally guaranteed by the director, government agency debts or debts that arise from environmental damage.  For further liability protection your corporation can be owned by trusts and holding companies.  For more on trusts see my blog series on the family trust.

The 3^rd area of reasons to incorporate has to do the fact that incorporation makes your business more attractive.  Many businesses seek to do business with corporations over sole proprietorships.  If you need capital from investors or the bank you will have much more of a chance of receiving it as a corporation.  Also some corporations will not hire sole proprietors for the job as CRA could deem sole proprietors as employees in some situations, which creates a huge CRA payroll debt!  Overall corporations are more attractive to do business with.

In my next blogs we will get into the timing of setting up a corporation and structuring your corporation.

Understanding the Basics of a Corporation

From the last 2 blogs we should now have an understanding of what a corporation is.  We will now go further into understanding the basics of a corporation.  A corporation is made up of 3 main people or groups of people:

1. Shareholder(s )– These are the owners of the Corporation.  Shareholders get to receive the benefits of owning the corporation, without taking liability.  There are various classes of shares that can be owned and we will go into these a little further in this blog, and deeper in a later blog in this series.
2. Director(s) – This is the person or group of people that have the ultimate control over what the corporation does and all the major decisions.  As also mentioned prior, the director(s) is/are the one that take the limited liability (see the last blog for examples of the limited liability)
3. Officer(s) – The officers of the corporation come with titles such as: President, Vice President, Secretary and Treasurer.  These are the people or the person that runs the day to day operations of the corporation. (in simplified terms)

As mentioned prior, to own a Corporation you must own shares.  There are different classes of shares in a corporation, such as voting, non voting and preferred shares.  Voting shares means that you have a voting right as a shareholder in things such as naming and firing directors.  Non voting shares means that you cannot vote.  Preferred shares means that you don’t have voting rights, but you may have preferential treatment when it comes to getting paid before common shareholders.  Typically preferred shares are for investors.  If something was to happen to the Corporation and it was going to go bankrupt, the preferred shareholders will typically get paid out before the common shareholders.  We will go further into depth on structuring the corporation in a later blog. 

The last point I’d like to cover in this blog is the fact that all corporations should have a minute book.  A minute book has the full record of the corporation’s existence and activity, proof of ownership and a lot more.  Many people try to save money by incorporating and not getting a minute book.  You are not doing yourself a favor as you will pay more in the long run to get the minute book done separately.  With no minute book, you have no record of your corporation’s decisions and no proof of ownership which will can come back to bite you later.  So make sure that if you incorporate you get a minute book.  We do incorporations at Kustom Design so don’t hesitate to ask us questions if you are thinking of incorporation or have an existing corporation.