You have three main ways you can structure your business. Just because you are in one structure now, does not mean it won’t be appropriate for you to change to another as your business changes. It is important to choose the right structure to reflect what you need.
- The first is a sole proprietorship and it is the easiest to setup and manage. All your business income is taxed personally and your personal assets can be exposed to creditors.
- The second is a partnership where you have one or more people involved in the business. It has the same limitations as a sole proprietorship. It is very important to get a partnership or shareholders’ agreement to govern the relationship between the partners.
- Your third option is to set up a corporation. The overriding idea behind this is to maximize wealth by paying the least amount of tax possible.
Ten advantages of setting up a corporation:
A professional corporation is an option if you are a professional aiming to provide your services through a corporation and you are regulated by a governing body, i.e. you are a physician, dentist, veterinarian, lawyer, accountant, architect, chiropractor, optometrist, engineer, or real estate agent. One of the main differences between a corporation and a professional corporation is how liability is treated. You need to be aware that there will be some variations between provinces.
- Limited liability. As a general rule, the shareholder is not responsible for the debts of the corporation. If it goes bankrupt, a shareholder will not lose more than their investment unless they put up personal guarantees for the debts of the corporation. Creditors of the corporation cannot sue shareholders for corporate liabilities. In a professional corporation you don’t really have limited liability; the liability protection does not extend to malpractice, meaning you cannot avoid personal liability for negligence by incorporating your practice though you do have some protection from creditors.
- Separate legal entity. The money and other assets of a separate legal entity belong to the corporation and not to its shareholders.
- Lower tax rates. Corporations are taxed separately from its owners and the rate is often lower than the individual tax rate of the owner. A Canadian-controlled private corporation has a lower tax rate on its first $500,000 of income.
- Tax deferral. One of the big reasons people set up corporations is when they don’t need to use all the earnings of their business in that year. The surplus income can be left in the corporation to be invested in assets that can grow or generate income. So the shareholder can defer this tax until they take it out of the corporation, often when they are in a lower tax rate in retirement.
- More access to money. A corporation can issue bonds or shares to its investors.
- Income splitting. Choosing any of the three ways to structure your business allows you to hire family members and split income with them, providing they are paid reasonably for their services. Where a corporation can take it to the next level is through dividend sprinkling. You don’t need to demonstrate that the family members have active participation in the business in dividend sprinkling. The corporation may issue shares to low-income family members of the professional and pay them a dividend. This option can save taxes as they are paid through the corporation instead of through after tax personal dollars, and may be a great way to pay for education or other expenses for children over 18.
- Capital gains deduction. If you dispose of shares of a qualified small business corporation, farm or fishing property in 2015, you have a lifetime capital gain exemption of $813,600. This gain is not subject to tax with increases indexed to inflation thereafter. At the time of writing, the proposed budget plans to increase the limit for farm and fishing property.
- Choose how you get paid. Salary or dividends or both.
- Continuous existence. When a partnership or sole proprietor dies, so does the business, but a corporation can outlive you. This stability opens the door for a different level of financial planning options.
- Choosing to end the calendar year when you like in a professional corporation can provide further tax deferral opportunities.