If you are in the process of becoming, or are already, an entrepreneur, a freelancer or a self-employed worker, you have probably heard about incorporation. For many years now, members of many professional associations have had the option of incorporating.
B.A.A., M. Fisc., Fin. Pl.
What is incorporation?
Simply put, it’s the action of creating a joint stock company – commonly called a “corporation” – to earn business income.
Myth no.1 – Being registered or incorporated is the same thing
- Being incorporated means creating a corporation. This corporation will receive the income from your business and pay the business expenses, and will have to file an income tax return.
- Registration is a much broader concept. Many businesses, whether incorporated or not, have to be registered in order to record all the information concerning their activities in a public register. An unincorporated entrepreneur could have to register his or her business but, unless the entrepreneur is incorporated, the income earned in the business will have to be declared on his or her personal income tax return.
Myth no. 2 – You have to have many clients to incorporate your practice
Every myth has a bit of truth to it. Since the tax treatment of a corporation may offer certain benefits not available to an employee, the tax authorities do not want a person who is normally employed by a business to offer his or her services to the business through a corporation. In such a case, the tax authorities deem that the corporation is a “personal services business” and the tax consequences can be harsh.
Whether you have only one client or dozens, make sure there is no ambiguity. If your entrepreneur status is clearly established, you will be free to use the tools required by your profession, choose your work schedule, perform mandates for other organizations, and much more. To avoid any problems, clarify your situation with the tax authorities.
Myth no. 3 – Being incorporated enables you to achieve tax savings
Incorporation does enable you to defer tax payments, which can be financially beneficial for you over time. However, we cannot really speak of tax savings. Here is an example to illustrate.
- In 2019, an employee with an income of $100,000 pays approximately $28,800 in taxes, excluding social security contributions.
- For the same year, a corporation with an income of $100,000 pays $15,000 in taxes. If the comparison were to stop there, it could seem that incorporation can result in substantial tax savings.
- In the case of a corporation, however, the residual amount of $85,000 ($100,000 – $15,000) cannot be used to buy groceries, pay a mortgage or cover any other personal expenses. To be able to use this money for personal purposes, it must be paid to the shareholder in the form of a taxable dividend. In 2019, a regular dividend of $85,000 is subject to a tax of approximately $15,800.
- An employee who earns an income of $100,000 would therefore pay $28,800 in taxes versus $30,800 for an incorporated entrepreneur, considering the tax paid by the corporation ($15,000) and the tax paid by the shareholder on the money taken out of the corporation in the form of a dividend ($15,800).
However, it is important to understand that by paying less tax, the corporation has more money available for investments such as buying new equipment or a new commercial building, or investing for the shareholder entrepreneur’s retirement. These benefits can be quantified in the long term and thus justify the incorporation of the practice.
1Assuming that it is a Canadian-controlled private corporation, that the number of hours worked by its employees exceeds 5,500 hours per year and that its business limit is above $100,000.
Myth no. 4 – Being incorporated enables you to deduct more expenses
Whether you are self-employed or you practise within an incorporated business, the expenses that you can deduct are essentially the same. The possibility of deducting more expenses should not be a decisive factor to incorporate your practice.
Myth no. 5 – An incorporated entrepreneur is protected against any lawsuits
A corporation is a legal entity separate from its shareholders. It can be sued and go bankrupt, without having any direct effect on the personal assets of its shareholders. However, care must still be taken. Despite a certain form of legal protection, a number of situations could still have a direct effect on the shareholders’ assets.
- Take the example of members of a professional order who may be found personally liable for malpractice, even if they practise their profession within a corporation.
- Another frequent situation is the requirement imposed by financial institutions that the shareholder guarantee the loans granted to the corporation. In such a case, even if the corporation is no longer solvent, the shareholder will have to repay the creditors from his or her personal savings.
In conclusion, the real value of incorporation depends on your situation. Whether from a tax or legal point of view, it can offer many benefits. Tax and incorporation professionals could help you determine the best business structure to limit financial risk and increase the protection offered by your corporation. An in-depth analysis of your situation and an assessment of all the factors involved are essential. To succeed in business, maximize your chances!
Émilie Beaudoin, B.A.A., M. Fisc., Fin.Pl.