A small business often comes as a surprise, albeit a welcome one. For instance, you start helping out a friend with catering for events. One event leads to another, and before you know it, you have to buy a diary to remember all your bookings! From there, you might decide to quit your full time job and turn your catering into a small business.
Small businesses have many decisions to make, and one of them is whether or not to incorporate.
There are a few benefits which will come your way if you choose to incorporate, which is the main reason why small businesses decide to go in this direction. The main reason, legally, is limited liability.
If you are sued by a disgruntled customer and you have not incorporated, e.g. you do not have limited liability, the customer could take you for everything you own, house and car included. On the other hand, if you have limited liability, you have a little protection and peace of mind. As you can imagine, that’s a huge relief for a small business, as a legal case such as this could end the business very easily. While limited liability won’t stop you losing anything, it will put a limit on how much you could lose.
Tax-Related Reasons to Incorporate
Another main reason is related to tax. Corporate tax levels are considerably lower than the rate of personal tax, and that means you could save yourself a good amount of cash every tax year.
Anther benefit is something called tax deferral. This means you can take money out of the corporation you own, and pay much less personal tax instead. You therefore defer the remaining amount of tax until a later date. There are limits on how to do this and how much you can take out, but it’s mostly around using dividends and salary.
Of course, there are a few downsides to incorporating, just as there are upsides too. If you incorporate you will need to pay fees, and you will need to fill in a separate form for your tax, which is a T2. This is in addition to your personal return. You’ll also need to ensure that you keep records correctly, as these could be audited at any time by the tax department.
When Should You Incorporate?
It really depends on the type of business you’re in. If your business has a high amount of liability risk, e.g. someone is quite likely to sue you, then the sooner you incorporate, the better in terms of protection. Other than that, it’s a personal choice to make, but it’s a good idea to flag this up when your small business starts to make profits which exceed the amount of cash you need to live well. This means you can start to take advantage of those tax benefits.
For any small business, the decision on when to incorporate needs to be thought about carefully. In terms of taking advantage of the benefits however, the sooner the better.
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- Written by: Jag Bath