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My 3 daughters, Lynae, Denise, and Meaghan (left to right)
I was asked by my daughters, Lynae and Meaghan, whether to incorporate their new company or not so I thought I would write a blog post about it.
Advantages
- Limited Liability – This is why companies are usually called something like XYZ Ltd. The alternative to an incorporated business is the sole proprietor or a partnership. With those two, all the liability lies on the sole proprietor or the partners. So if someone wants to sue your company, then they only sue incorporated company. Also, if the corporation becomes insolvent, then the creditors cannot come after the shareholders.Reality – We now have the “law of deep pockets” which means you can sue anyone and everyone. So if someone sues, they can sue the corporation, you and anyone else they may deem has something to do with it. If you are proven to have 1% blame and you have 100% of the money, you will end up paying. So in reality, having your company incorporated doesn’t really help the potential litigation problem. Also, banks will not lend to a new corporation with no assets and so the shareholders end up personally signing anyway.
Conclusion – To incorporate for Limited liability doesn’t give any real advantage for small businesses that are just starting and doing it for this purpose. - Taxes – In Canada, the effective corporate tax rate is 15% so you will have less tax to pay on your profitable business.
Reality – Most small business owners want to take all the profits and use it now so they might as well forget the tax break as eventually you will end up paying more tax. Here is an example. Year one your corporation makes $100,000 and so you take out the $100,000 in wages and you pay around 19.5% and the corporation makes zero because they paid all their profits in wages; no tax advantage. Another example. Year one your corporation makes $100,000 and you leave it in and wind up paying $15,000 in taxes; you now have $85,000 left in the corporation. Then if you want to take the money out the following year, you only have $85,000 (after corporate tax) to draw from and then you will have to pay approximately 19.5% personal tax on it. In effect, you now paid double tax. So it is just better to take the hit and not keep it in the corporation - Cost – It will cost you between $200 (on line, do it yourself)-$1000 (pay some experienced person to help you) to set up your business and you will need to do two income tax returns; personal and corporate. You will also need new bank accounts, cheques, business cards and more. That is just start up costs. On an on going basis, our corporate taxes cost us about $800 per year on top of our personal taxes.
You also have to file on line, once a year for $20. If you miss it, you will lose your incorporation within about a year and a half. You have to remember. You also have to have a shareholders meeting and keep notes at least once a year. If you decide to change banks, take out a loan, or make other decisions, they should be recorded in your corporate journal.
We went incorporated for a different reason. Our company obtained contracts from large corporations like Dow and Exxon. Some of those companies got burned with long term contract employees suing for benefits after a protracted period of time and the courts sided with the contracted employees. This caused them to require that they only hire a contract person through another company. By having my own limited company, it satisfied their hiring requirements and I could obtain the full rate without having to give up part of the pay through a head hunter company.
If you plan on being a large company, with many employees, it is wise to incorporate. If you are planning to only have you as the sole employee, most people find it encumbering and regret the move as they find it hard to realize any advantages. I have had a few friends that incorporated and then dissolved the corporation after a few years.