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Should You Incorporate Your Small Business?

Updated: Sep 27, 2022

As a CPA, this is probably one of the most popular reasons new clients come to see me - and it's a great question.

I hope that by the end of this article you will feel confident making the right decision about incorporating – or not – for your business

Article Written for TaxWrx by Chartered Professional Accountant Jillian Battaglio.

To help explain the importance of this decision I am going to tell you about two different client experiences.

When Incorporation Was A Bad Choice

Our first business owner had a small but growing sole proprietorship.

They had developed excellent branding, were building great customer loyalty and were steadily seeing results in their business.

After a few internet searches and speaking to some personal acquaintances they dove into incorporation.

They thought it was the right move that would bring their business to the next level.

This didn’t end up happening.

Before incorporating their business profits were relatively low and the additional costs of incorporating along with the annual maintenance fees that come with it began to stifle their growing business.

Adding to this were the additional administration tasks that smothered this already overwhelmed business owner.

Several years later, they still hadn’t found their footing and began the process of returning to a sole proprietorship.

A simple structure was the best choice for this business owner and operating as a sole proprietorship allowed them to course correct and begin the trek back towards profitability.

If this business owner had asked a few questions before deciding to incorporate they could have saved a lot of money and stress.

Let’s go through a few of these questions so you don’t make the same mistake:

What To Ask Before Incorporating Your Small Business

Before taking the plunge into incorporation, a few questions can save you a lot of stress:

  • Question 1: Will I make more than $80,000 of net income in my business every year? To calculate net income subtract your estimated revenue from estimated expenses. Any less than $80,000 and you won't see sufficient benefits from incorporation to make the extra costs worthwhile.

  • Question 2: Will I be able to leave $30,000 of business profits in my business bank account every year to compound, or do I need all money for personal use? Money removed from a corporation does not benefit from lower tax rates.

  • Question 3: Am I a proactive person who plans ahead? Procrastinators benefit less from incorporations because timing is crucial for effective tax planning.

  • Question 4: Will I be able to manage the extra administrative requirements and multiple tax deadlines that come with incorporation? Do I feel confident in my organizational skills?

  • Question 5: Am I prepared for the additional costs? Annual expenses can range from $2,500 - $5,000. Can my business handle this?

If you answered ‘HECK YES’ to many of these questions – then incorporating may be a good option for you.

"Will I be able to leave $30,000 of business profits in my business bank account every year, or do I need all money for personal use?" – Jillian Battaglio, CPA, CA

When You Should Have Incorporated Right Away

Our second business owner also started as a sole-proprietorship.

Their business began to flourish early on.

Excellent branding, a marvellous product, and a focus on their customer’s experiences helped this business to take off.

In fact, the growth was exponential.

They needed to expand but adding more assets to their sole proprietorship was only going to add tax complications down the road.

They also wanted to begin building their personal wealth and were looking at investing in real estate and home ownership.

They didn’t want to put these assets at risk while operating as a sole proprietorship in an industry prone to inquiries and lawsuits.

Looking ahead they could see the potential in their business and knew that one day selling for a substantial sum or even franchising might be an option.

They decided to incorporate but the journey wasn’t easy.

Taking a very successful sole proprietorship into a corporation structure meant extra valuation costs and tax rollover procedures that added thousands of extra accounting and legal fees to the process and slowed things down.

The extra costs and a delayed expansion meant their business stumbled in the first few years after incorporating.

Luckily it didn’t last long and incorporating meant access to funding and extra-financial reporting options that allowed them to thrive.

By incorporating early, they could have saved themselves money and stress in the long run.

What to Ask Before Choosing a Sole-Proprietorship

When starting a business a few extra questions you want to ask yourself include:

  • Question 1: Do I anticipate selling this business in the future for a substantial sum? Will I want to use the lifetime capital gains exemption?

  • Question 2: Do I have personal assets like retirement savings or real estate that I want to protect from lawsuits? Is liability a concern with this business? Will insurance not be enough?

  • Question 3: Do I anticipate exponential growth because I am going to focus on branding and marketing?

  • Question 4: Will I need to make significant investments into equipment, machinery, or leasehold improvements?

  • Question 5: Will I need access to financing now or down the road? Will I need formal financial statements to facilitate this?

If you answered ‘HECK YES’ to many of these questions, then incorporating may be the right choice for you.

No Best Structure For All Small Businesses

It's an individual choice.

I hope these examples have illustrated that incorporation is a complex decision and it isn’t the right for many business owners, but it can be a crucial tool to help others grow.

Before making a decision, I would encourage you to check out our video collection and take a look at our incorporation handout available in our paid plans to help you make the best decision for your business.

Now there are two additional complexities on this topic that I cover in other videos.

  1. The first is real estate rental properties held in corporations and the big tax surprise that investors will want to know about.

  2. The second is something called a personal services business which is really important for subcontractors to understand.

If you think either of these applies to you – please, please check out our other articles and videos before making an incorporation decision.

I hope this article has helped provide you insight into whether incorporation is the right decision for your business.

If this topic has interested you, be sure to check out our other blog articles and consider subscribing to one of our membership plans so you can be a well-informed business owner.

Article Written for TaxWrx by Chartered Professional Accountant Jillian Battaglio.

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