Are you a small business owner running the business as a sole proprietor or partnership? There comes a point when the business scales, and the only thing hindering its growth is the business structure. As a business owner, when making business plans and strategies, you ask yourself, is now the right time to incorporate the business? Has the business stabilized? Are you ready to handle the expenses and responsibilities of incorporating a business?
While the ultimate decision is yours, we can break down the logical reasoning of the right time to incorporate a business.
Leaving The Comfort Zone of Sole Proprietorship
A sole proprietorship is a one-man-show where you are your boss, shareholder, and partner. You are in full control of how to run the business. Your business income and personal income are the same. Hence, you pay personal income tax on your business income. However, you can deduct business expenses from your taxable income.
Self-employed individuals have fewer regulations to abide by and face a lower risk of CRA audits. You are used to doing business your way, and it is reflected in your offerings. These advantages are hard to let go.
But as your business grows, so do your responsibilities. You have two options: expand or be comfortable with the existing size.
Signs Your Business Needs To Be Incorporated
Even though sole proprietorship is the simplest and easiest business structure, it has its limitations. And when these limitations overpower the advantages, you feel the need to upgrade. Think of it like this: when your child’s shoes don’t fit, you know it is time to buy bigger shoes. Because your child won’t be able to walk far in smaller size shoes.
Similarly, you must understand if your business is crumpling into a smaller structure. Do you need to give it more room for growth? Here are some signs that can help you determine whether you need to incorporate.
Business Liabilities Grow Bigger Than Your Personal Assets
No business is without liabilities. For a sole proprietor, their money, assets, and investments are a part of your business. It is better to keep your debts and liabilities limited to a level where you don’t lose out on your house and other assets. But sometimes, you take on liabilities to expand the business. And if they outgrow your personal assets, it is time to reconsider your business structure. Because if you get sued, you could lose your personal assets.
Incorporating will separate your business and personal assets and liabilities by making your business a separate legal entity. When you put some assets and liabilities under the business name, you protect your personal assets from business risk and your business assets from personal liabilities.
Higher Profits Are Increasing Your Tax Bill Significantly
Another sign is rising profits. When you operate as a sole proprietor, your business profits are taxed as personal income tax. As Canada follows a progressive tax rate, the higher your personal income, the higher your tax rate. Any income earned above $235,675 in 2023 is charged at a 33% tax rate, leaving you with less money to reinvest.
If your tax bills limit the cash in hand, you might consider incorporating your business. An incorporated business can avail a small business deduction that charges a nominal tax on the first $500,000 income. You can use the tax savings to reinvest in the business. You can also withdraw a higher amount from your business in a tax-efficient manner through income splitting.
Also, an incorporated business can avail itself of several tax benefits that a sole proprietor cannot. A professional accountant can work out the math and help you understand the tax savings incorporation can bring.
Raising Capital and Finding Investors
Another thing to consider is how fast your business is growing. Do you need to raise capital to fund this growth? Raising capital at an individual level can be challenging. Banks and investors might not be willing to give an individual a business loan.
However, incorporated businesses have more financing options. If you have operated as a corporation for at least three years with at least five people on payroll, you can look for government funding. Moreover, angel investors and venture capitalists might ask you for an equity stake in the business for which you must incorporate your business.
If you want your business to outlive you and take care of your employees and family after you, you have to plan early. Transferring ownership of a sole proprietorship is tough, as your business may fall apart without you. However, an incorporated business has shares that can be transferred to your children or employees or sold to a third-party tax-efficiently with proper estate planning. You may retire and live off the dividends from shares or proceeds of the sale. The CRA gives you a long-term capital gain exemption on gains from the sale of company shares.
Incorporating a Business is Expensive and Complex
While incorporating a business might sound attractive, it is complex and expensive. You must prepare ‘articles of corporation’ and submit them to the government.
An incorporated business has a lot of legal paperwork and regular accounting requirements. You need to determine the share structure, salaries, and dividends. Moreover, incorporated businesses are more likely to be subject to CRA audits. You need to work with a professional accountant to see if the tax savings and asset protection more than offset the legal and accounting expenses of incorporation.
The cost is one angle. More owners mean reduced control of the business and higher chances of internal conflicts. You should be prepared to take up such challenges.
Now, you don’t need to have a more significant business to consider incorporation. There are single-person organizations that incorporate to avail the tax benefits and have access to better financing. Some even incorporate it to get business licenses and build a brand, a professional legacy.
As we said before, finances are one aspect. The decision to incorporate also depends on your plans for the business.
Contact Glenn Graydon Wright LLP in Oakville to Help You With Business Planning
A professional business consultant and accountant can help you determine the accounting and procedures for incorporating a business. To learn more about how Glenn Graydon Wright LLP can provide you with business planning and accounting expertise, contact us online or by telephone at 905-845-6633.