Filed Late? Here's Exactly What CRA Will Do Next

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The growth of a business brings about many important changes. Financial expansion, as with geographical expansion, must be carefully managed to ensure the business is operating as effectively as possible. Among the many factors to consider is the operating structure of your organization. A business can operate under any one of a number of different structures, including a sole proprietorship, a partnership, or a corporation. A new business most commonly begins as a sole proprietorship. As it grows, however, incorporating a business can lead to significant benefits. The following will outline some of the issues involved with incorporation and help you assess at what point you may want to adopt a corporate structure.

If you earn income through a corporation, the income will first be taxed at the corporate level. When the earnings are paid out of the corporation in the form of salary or dividends, the income is then taxed again at the personal level. In theory, the total corporate and personal income tax paid through a corporation should equal the personal tax that would be paid on the same income earned directly by an individual taxable at the top marginal rate. Although this is not always the case in practice, incorporation is generally not a good idea if you rely on all of your business profits to support your personal cash needs. Significant tax savings usually arise only if you are able to reinvest some earnings back into the business.

Under normal circumstances, an unprofitable business (such as one that is in the startup phase of operations) should not incorporate, since corporate losses can only be used to offset corporate income. A sole proprietor, on the other hand, can use business losses to offset other personal income.

Therefore, a corporate structure is most beneficial when a business becomes profitable and at least some the net earnings can be reinvested in the company. The following are some of the benefits of incorporation:

• Access to the small business deduction – a low tax rate of approximately 18% (which is scheduled to drop over the next few years) is available on the first $200,000 of business income.
• Limited liability – incorporation can limit your personal liability by keeping your personal and corporate assets separate. However, since banks often ask small business owners for personal guarantees on loans, incorporation may not protect you from all creditors.
• Income splitting – if your spouse and adult children are shareholders in the corporation, any dividends they receive will be taxed in their hands. The corporation can also employ family members of the owners as long as the amounts paid are reasonable for the work performed.
• Capital gains exemption – provided certain conditions are met, a $500,000 capital gains exemption is available when the shares of the corporation are eventually sold or transferred through a will.