If you’re a small business owner (or thinking of starting your own business), you may be wondering how to structure your company in the future. Imagine you are the owner of a food truck that sells homemade sweets. Through loads of hard work and a small loan from family, you’ve turned grandma’s recipes for cakes and fudge into a successful small business. Currently you’re only hitting the farmers markets, softball games, and other small local events but you can see the potential and want to “go big”. Should you turn your small business into a corporation? What will change if you do?
- Sole proprietorships and partnerships are, in effect, extensions of their owners.
- Corporations are an entity all their own.
The best example of this is how liability issues are treated. If your food truck’s door accidentally slams shut on a customer’s hand and causes extensive damage, how much personal liability you have changes drastically depending on the structure of your business.
If your business is a corporation, the business itself assumes the liability. In other words, the corporation will pay out from the corporation’s funds. This limited liability means you can only lose the money you’ve invested in the business. Your personal assets/savings won’t be touched.
If you are a sole proprietor or member of a partnership, your liability is unlimited and you’re personally responsible for any damages. This means that the customer could receive a judgement against you, forcing you to pay out of your own pocket.
How Incorporating Your Small Business May Affect Your Taxes
Many owners of small businesses wait until their ventures are making money before making the jump to incorporation due to tax reasons. If you’re the owner of an unincorporated small business, the profits or losses your business incurs are directly linked to your personal taxes. If the business loses money, the loss can be applied to your other income. Similarly, any profits your business makes are added to your personal income.
Corporate tax rates are generally lower than personal tax rates, assuming your business is yielding a good profit. If your food truck becomes a hit locally and your profits explode to $200,000 for example, your personal tax rate as a sole proprietor will skyrocket to approximately 24% federally, not including the provincial equivalent. If your food truck is incorporated, that federal rate could fall as low as 11%.
Some tax breaks are only available to small businesses if they are incorporated.
The Small Business Deduction, for example, lowers the tax rate for qualifying small business corporations. Additionally, if you’re planning on selling your shares of the business in the future and want to take advantage of the Lifetime Capital Gains Exemption, your business must be incorporated.
Grants, Loans, and Investors
If you’re looking to expand your business, incorporation may open a few extra doors.
Many banks and investors require that your business be incorporated to show you’re “in it for the long haul” and committed to the venture. If you’re looking for a grant to help fund a second food truck, more options are available to you if you’re incorporated.
Rules and Regulations
Ah the paperwork. As a sole proprietor, you decide how you run your business. Other than day-to-day bookkeeping, government remittances (such as payroll deductions and GST/HST amounts), and filing your tax return, the amount of paperwork you need to complete is relatively small.
Corporations must follow a strict set of rules and regulations. These include:
- holding shareholders meetings
- filing annual reports with the corporate registry
- filing a separate tax return for the business
- other administrative tasks
Extra costs resulting from incorporation
In addition to the initial fees to set up your corporation, you may also incur costs to ensure you’re complying with these corporate regulations. This may include hiring a professional bookkeeper, consulting a lawyer, or simply the production time you lose by doing these tasks yourself.
The decision to incorporate isn’t one to be taken lightly. Like any business decision, be sure to do your research. Contact Service Canada or search the Canada.ca site for small business tips. Visit a small business center in your area. Chat with your financial advisor or set up a meeting with your bank. Find the option that best suits your business.
Whether you decide to incorporate or remain a sole proprietor, TurboTax has you covered at tax-time with simple to use, affordable tax preparation options. For sole-proprietors, we recommend our TurboTax Self-Employed version, which provides expert guidance on self-employment income and expenses, including businesses on the side and home-based businesses. And if you’re incorporated, our Biz Inc. version provides the guidance you need to file your T2 Incorporated return with confidence.
Jennifer is the Social Care Manager for TurboTax Canada. When she’s not helping customers on Facebook, Twitter, and TurboTax’s community forum AnswerXchange, Jennifer is busy researching the latest tax changes.
Jennifer has been preparing tax returns for over 30 years and enjoys holding tax seminars for seniors in her hometown of St. Vincent’s, Newfoundland.