I’ve been toying with the idea of incorporating my business since I became self employed. After consulting with my lawyer and accountant when I started, we all felt it would be best to be a sole proprietor.

I am now revisiting the decision because I will be moving into a higher tax bracket and another accountant gave me a different perspective on the situation.

There are many other choices for most people, but my situation narrows it down to two: Sole Proprietorship or Corporation. Below I list the most significant advantages of each entity for my case.

Reasons for being a Sole Proprietor:

Business Losses: Business income is your personal income. So if your business efforts in one area operate at a loss, you can use this to offset earned income from other sources. This is beneficial to me for my investment property, where I have made significant renovations that create a total expense amount greater than my income for the year. I am able to use this against income earned from my other sources.

However, operating losses for a corporation cannot be carried through to shareholders. If this was the case there’d be a rush to own a piece of GM or Ford!

Lower Operating Cost: I had no start up costs as a sole proprietor. I registered with the Government of Canada to receive a Business Number. After receiving my business number I was able to start operating. Accounting and legal requirements have been very low. I have only consulted my accountant prior to filing taxes to review certain rules and clarify my final numbers. This process took about 2 hours over 2 days.

Conversely, a corporation would cost about $1000 to set up with my lawyer. This would involve filing articles of incorporation with the federal government and developing a shareholder agreement. It would also require me to file a corporate tax return on top of my personal return each year. This incurs additional accounting costs.

Reasons for Incorporating:

Lower Tax Payments:
Income coming into a corporation is taxed at the corporate tax rate. In Ontario, one has to apply the federal and provincial corporate tax rates. Many reductions are available for a variety of reasons, such as having income less than $400,000 and being a Canadian controlled private corporation. My 2008 tax rate on business income would be 16.5%.

I would then pay myself a salary (taxed at personal income rate based on salary amount) or dividend (rate depends whether it is eligible or ineligible) in the amount of my choosing.

It may seem obvious, but you do not have to pay out all profits to shareholders. My business is getting to the point where I am able to leave some earnings in the corporation and still be able to pay myself an average salary. Relative to a sole proprietorship, where I have to claim all income as personal income (and pay income tax on it), I will pay less tax because my earned income will be lower. A portion of the income going into the corporation will not be passed on to me, therefore it will only be taxed at the corporate rate of 16.5%.

Money left in the corporation can be invested (stocks, bonds, etc.) or used to grow the business.

Over the coming week I will be looking to quantify tax savings and analyze the overall benefits of incorporating. Even though it will be more work, tax savings might just make incorporating worthwhile.

Hopefully I’ve provided insight into my decision and helped out my fellow self employed Canadians! I’ll let you know how I proceed.