Tax Concepts for Growing Businesses – Incorporating vs Sole Proprietor
Tax planning is one of those tax concepts that business owners either love to work on or avoid like the plague. The problem with the tax act, and most tax concepts, is that it’s not a “one size fits” all application. In most cases, we need to understand what you’re doing and then plan accordingly while applying the various tax rules. Different people have different considerations, and the needs of two people are never the same. One of the biggest questions I get asked from new business owners is “Should I incorporate my business?”
Tax Planning Areas
There is a fundamental difference when you incorporate your business versus running as a sole proprietorship. As a sole proprietor, the legal entity of you and your business are the same, there’s not as much tax planning or strategy we can do. When you incorporate, you create a new legal entity. Since a shareholder can take on both an employee role and an owner role, tax planning and strategy is now a viable option! Some of the decisions to walkthrough are:
- Dividend vs Salary – a dividend is only payable to shareholders, and all shareholders must be treated the same. A salary is paid to employees and subject to CPP and EI. Each has a tax consequence to the individual recipient but because a salary and dividend are taxed differently, we can decide when and how much to issue!
- Investment – a corporation also has the ability to invest in the market; so if the shareholders choose not to withdraw the profits of the corporation, we can invest them. This eliminates the personal tax consequences of withdrawing money from the corporation!
- Insurance and Benefits – a corporation can also purchase insurance and benefit plans on behalf of its shareholders/directors. This has to be set up properly to avoid deemed taxable benefits to the beneficiary, however.
- Estate planning – as the corporation grows in value, we can start planning how to transfer the wealth to children/dependents in a tax-efficient manner
Typically we find people incorporate for one of three reasons:
- Legal protection – check out this great blog for legal reasons to incorporate HERE from our favorite business lawyer Andrea Henry.
- Financing reasons – many lenders or franchisors will not do business with you if you aren’t incorporated
- Tax planning – see the list above!
It’s never a one-size-fits all scenario so make sure you seek professional advice to understand if incorporating is right for you!